Can you talk a bit more about the dilution an employee should expect if the company completes more funding? That could have a serious impact on your shares. Who usually gets diluted first? Founders? Previous investors? Employees?
If you're an employee that received options and the company is doing another round of funding, should you be worried or on the front foot about finding out what will happen to your options?
Everyone gets diluted when a company raises more money: founders, employees, and previous investors. Investors usually have ‘prorata rights’ which mean they are allowed to invest additional money at the new valuation to maintain their given percentage ownership of the company.
Founders generally have the same class of stock as employees (common stock), and so are in the same boat.
Investors have preferred shares. Preferred shares have a few special properties, but the most important is ‘liquidation preference’, meaning they’re first in line to get their money out if things go wrong. Sometimes investors have a right to a multiple on their money back: twice their money would be a 2x liquidation preference.
One thing to ask about in the case of a company that has raised money on convertible notes. Since they haven’t actually sold equity, but only debt which will later convert equity, it’s worth asking if a given stake is before or after those notes convert.
Generally, if things are going well, dilution isn’t worth worrying about. In any case, the founder will be just as diluted as any employees, so their interests are aligned.
> Generally, if things are going well, dilution isn’t worth worrying about
Just to clarify...
People who are just learning about this stuff (and many who aren't) learn about dilution and think it's total bullshit, get concerned about how much they're being diluted, feel like they're being stolen from if there's a dilution event, etc etc etc. The idea, however, is that if you're being diluted it's because someone wants to give the company money, and that's usually because the company is growing. Your piece of the pie will shrink but if your execs know what they're doing the pie will grow more than your piece will shrink and you will come out ahead in the end.
> Founders generally have the same class of stock as employees (common stock), and so are in the same boat.
Not quite - Another extremely important point is ensuring that there isn't a hidden type of equity/option ("Series FF" or alike) sitting above you as an employee. In this situation founders are less aligned with you as an employee as they get the option to cash out rather than being diluted in follow-on rounds. This is a mechanism designed to align founders with investors by causing founders to shoot for the moon even through appealing exit offers, but has the side effect of allowing them to stop caring and not exit until it's too late (they've got theirs, after all).
Earlier investors usually have the option of reinvesting (at the new valuation) in order to maintain their proportion of the company. Typically, they also get the same terms (which tend to propagate to all the investors in the round.) This is why taking shitty terms early on can damage you, even if you think the 5x liquidation preference you took on that $1 million A round "shouldn't" matter. On its own, it's only $5 million, but you're likely to face MLP (and participating preferred, which is also horrible) in all future rounds.
Founders and employees do not get to reinvest. Typically, when a VC-funded company is allowing employees to buy more equity is the last time to take that deal (it means the company is cash-poor and in bad shape). General rule: unless you're a founder, avoid taking the other side of any deal with VCs in it.
If you're an employee that received options and the company is doing another round of funding, should you be worried or on the front foot about finding out what will happen to your options?