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Comment by stmfreak | Hacker News Reader

The path to liquidity is not always straight up and to the right. Some funding rounds can drastically revalue prior shares through reverse splits. This can make your 1% stake magically turn into a 0.05% stake in a single funding round. Even if they don't reverse split, funding rounds issue new shares which is dilutive if you do not also get an additional grant. Once you leave a company, your precious few shares get diluted and reverse split with all the funding rounds between your departure and the liquidity (IPO or acquisition) event.

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Does that just happen with stock options or normal stocks as well? It would seem that if there are 100 shares and I have 1, then it should be worth 1% of the company no matter how successful it becomes. I can understand how options might be subject to tinkering, but if stocks are as well then the whole thing sounds like a racket.

I just mean that the idea of dilution suggests to me that the original company has been dissolved and reconstituted somehow. That sounds like something seriously in need of regulation...

This doesn't sound like what happened in the case here, but dilution can happen due to reasonable funding rounds. If you own 1 share out of 100 and then the company decides to go to some investors and raise $10 million, they might give those investors 50 shares, meaning the company now has 150 shares, the new investors own a third of the company, and you own 2/3 of a percent of the company instead of 1 percent. Where this gets messy is if shenanigans are used to dilute particular shareholders (e.g., after some event you now own 0.001% and someone else's portion is unchanged) or other such things.

Edit: I should add that even publicly traded companies do this, issuing more shares and diluting current shareholders to raise capital.

>> "then the whole thing sounds like a racket."

Yup, that's it exactly.

So how do you protect yourself against this? Is there something you can put in the initial contract to prevent reverse splitting in the future?

There are so many ways to screw you, that your best protection is a management team you trust.

I'd argue that the best protection is the advice of a lawyer, and not to mix trust with financial matters. History is strewn with tales of people who trusted other people with their money.

> I'd argue that the best protection is the advice of a lawyer

That advice turns into: "You could fight this and possibly win, but it would take a year and it would cost more than you'd get back." I get what you are saying. You definitely can't really "trust" anyone, but there are so many ways to legally screw you that I'm not sure you can trust protection using a lawyer.

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