Stock options: shares reserved pool raises key issues.

A company that is going public frequently lavishes executives and employees with potentially lucrative stock option grants at the time of the company's initial public offering (IPO)--grants that will be worth far more than their weight in gold if the company's stock experiences a run-up in share price.

But it gets even better for executives and eligible employees, says PricewaterhouseCoopers. Granting of gilded-edged stock options does not end at the time of the IPO, but is only the beginning. Executives and eligible employees can look forward to periodic grants of stock options for as long as the company remains public and they remain with the company.

This begs an obvious question, say consultants in PwC's human resource practice: Where do all the shares of employer stock come from to fund IPO stock options grants and post-IPO stock grants? The answer: From the "shares reserved" pool, which represents the number of shares of common stock that a public company specifically earmarks for purposes of funding stock option grants (or any type of equity compensation grant).

The number of shares set aside in this pool raises a host of critical and potentially controversial issues that must be dealt with by a going-public company, PwC says. These include:

* Shareholder dilution. Shareholders, particularly institutional shareholders, have become more sensitive to dilution issues raised by the size of shares reserved pools. The larger the pool, the greater the dilution. A company's board and management must be prepared to defend the company's shares reserved pool as reasonable and aligned with corporate goals and pay philosophy.

* Funding requirement. Balanced against shareholder dilution concerns, a public company needs a shares reserved pool ideally large enough to fund at least three years of projected stock option grants. Precipitously draining the pool in close proximity to the IPO presents two interrelated concerns for a new public company:

1. Not having options to grant to existing employees and new hires, at least the shares reserved pool is increased.

2. Requesting shareholder approval to add to the pool, a request that may not be viewed very favorably by institutional shareholders.

* Competitive practices. An overlaying concern is whether the relative size of the shares reserved pool is consistent with practices of publicly traded peer companies. A pool that is within competitive practices will be more easily defensible than one that is not.