Just got a job with what I think is reasonable equity but I know we're raising more capital soon. How should I discuss how my options are diluted over time?
Possibly a bit obvious, but it might be worth considering what constitutes a 'bad deal' in the context of Tim's original post. I'd expand this into a 2-part concept and suggest that you want to be confident that the leadership of the company can (a) use the investment raised to create value and (b) negotiate to realise that value in subsequent investment rounds.
To protect the value of your stake,you want to be sure that the pre-money value of each investment round is greater than the post-money value of the previous round (not just pre-money to pre-money).
In the example above (assuming +4 friends!)at the completion of the first investment round the investor has 250 shares and the 5 founders have 100 shares each, all valued @ $1.
If you're a founder, your stake is worth (on paper, at least) $100.
Now assume that you need to raise $500 to fund the next stage of growth.
Let's say that you find an investor who's willing to fund that at a pre-money value of $1125 - i.e. a share price of $1.50 * the 750 shares then in issue.
Now your stake as a founder has fallen from 13% to 8%, but your 100 shares are worth $150. The first investor is diluted from 33% to 20%, the new investor has a 40% stake and the company has a post-money value of $1625.
Hence the need to see a steady increase in value from the post-money value of each round to the pre-money value of the next, which also gives an indication of the efficiency of the company in converting investment capital into value.
So in and of itself, dilution is not necessarily a problem,although it can be an issue where a shareholder or group of allied shareholders are diluted past a control threshold.
It is worth noting that in practice many companies have preference shares in their capital structures, and these can have a very significant impact on the returns to ordinary shareholders in a liquidation event.