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I am considering joining a startup as employee #2. I expect to receive some equity (either stock or options).

Is there any way in which I can protect myself against the founders simply issuing themselves more shares after I join, thus diluting me?

Note that I am not asking about dilution as a result of new investment (from outside investors). Instead, I am concerned with the situation where the founders simply draft documents to create a ton of new shares at a very low par value and then issue those shares to themselves.

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I found the answer after searching google for information about down rounds.

For a detailed explanation, see: http://www.startupcompanylawyer.com/2008/11/21/how-can-a-board-decrease-litigation-risk-in-an-insider-led-down-round-or-dilutive-financing/

In short:

  • The owners have a responsibility to the shareholders
  • Actions of the board are presumed to be in good faith
  • When the board is composed of insiders representing a controlling interest in the corporation, and the insiders decide to lead a down round of investment, then, depending on state law, this presumption falls away.
  • Courts can then elect to void the down round. Also, the directors can be held personally liable for their actions.
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The only way to really protect yourself against this is to make it part of your employment agreement.

The reality is that through one thing or another you will almost surely get diluted over time, so it may be easier to negotiate a higher initial percentage, keeping in mind that you will likely end up at 25% of that number over time.

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