How much is a founder allowed to dilute stock? [closed]

Question

I am 9 days away from completing a contract for a new start up that still has yet to raise money. At the beginning I negotiated 1% of the company, and a month into the contract he incorporated the company and we amended my contract to be 1% of the common stock he incorporated with.

This morning he told me that he was going to be diluting the stock by 100 times.

he gave me 2 options:

A. Sign another contract for at minimum 3 months, re-vesting me back up to what 1% of the shares will be, or

B. Walk away at the end of my original contract with the amount we amended my contract to, which would turn into 0.01%.

Is he legally allowed to do this and is there any other options I can take?

I am really angry that he essentially devalued my work by 99%. Should I trust him enough to sign for another contract.

I am sure that I will end up working at another start up again in the future, what can I do to protect myself from something like this happening again.

Edits Below ==========================================

So basically, because the CEO was in a rush, and failed to fully explain all the details to me, almost all the above information is either incorrect or pretty inaccurate.

He let me know a little bit about what happened, and then I mistakenly jumped to conclusions, and let my anger get the better of me, and led me to writing the above post.

I'll take this as a lesson to better everything about a situation and keep a level head

Answer 1

To bluntly answer your questions:

1. You shouldn't trust them, unless they were quite explicit with you up front that this might happen, this is a pretty sleezey move to pull. This isn't the sort of behavior I'd expect from someone capable of eventually brining the company to successful exit for investors such as yourself. It seems both amature and immature since they should be diluting their own shares (which they may be doing now as well), not yours.

2. There are things that can be placed into equity agreements that prevent this sort of thing, such as clauses specifiying conditions under which shares can and cannot be diluted (including undiluable shares).

Answer 2

You should talk to a lawyer with the exact words of the contract. What can or cannot be done would depend on how the current contract with you is worded.

we amended my contract to be 1% of the common stock he incorporated with.

Is there something written that says he cannot create more common stock and if so you would be granted 1% of all future new common stock created? If not then there is very less grounds.

I am really angry that he essentially devalued my work by 99%. Should I trust him enough to sign for another contract.

There are multiple ways to look at this. If the new funding essentially will help the company grow faster, it would make your holding more valuable. Never trust anyone always have contracts reviewed by lawyers.

Answer 3

This morning he told me that he was going to be diluting the stock by 100 times.

That means "issuing a lot more shares of stock".

Is he legally allowed to do this

The Board of Directors -- voted on by the shareholders and thus controlled by the majority shareholder -- is definitely allowed to vote to issue more stock.

Sign another contract for at minimum 3 months, re-vesting me back up to what 1% of the shares will be I am really angry that he essentially devalued my work by 99%

Since he's offering to revest you back to 1% for a measly three month contract, there's something you aren't telling us.

Is it an exclusive contract?
Was the original contract only for a month before you leave town for a different contract?

Answer 4

If it’s being done legally, diluting your stock makes no difference to your financial position, unless there are agreements you’ve not told us about. Suppose the company was worth $100,000 and there were 100 shares, so your 1% was one share worth $1,000. Now the company has issued 9,900 new shares. But initially it holds them in its treasury, so your 1 share effectively owns 99 of the new ones. And if they’re sold at market price to raise money for the company, they bring in $9.9 million, the company is now worth $10 million, and your 0.01% of the much larger company is still worth $1,000. There’s only a problem if they’re being distributed at less than the market price.

Answer 5

First of and most important thing to do: Do NOT sign any new contract.

Then you can examine the original contract for clauses on dilution and consult a lawyer on your possible strategy hereafter.

Other than that, consider this: Would you like to work for a guy that essentially screwed you over for another 3 months based on their word they shall not screw you over again? Or in G.W. Bush's words as the saying goes ...

Answer 6

I am 9 days away from completing a contract for a new start up that still has yet to raise money. ...

This morning he told me that he was going to be diluting the stock by 100 times.

These two statements don't go together. Stock dilution is when a company increases its value through issuing equity, making its shareholders own a smaller share of a larger value. If done correctly, shareholders end up with the value of their equity stake being the same or larger than before. Poorly done, shareholders can end up with a lower value, and there are ethical issues as far as the people in charge of a company acting in the shareholders' interest.

You don't give any numbers, so I'll make up my own that should be within an order of magnitude or so.

Say he offered you stock valued at $25,000 for three months work. Since this is 1% of shares, that means the company is valued at $2.5m. For the stock to be diluted 100x, it must now be worth $250. So there's an extra $247.5m that must be from somewhere. Did he hire several thousand other people and offer them stock? Did he sell several million dollars of stock? Or did he just unilaterally declare that the company is now worth $250m, and you are somehow not entitled to your 1% of the massive increase in value?

A. Sign another contract for at minimum 3 months, re-vesting me back up to what 1% of the shares will be, or

And the plot thickens. If the company truly is worth $250m, then he's offering you $2.5m for three months of work. So either he thinks that you're an incredibly valuable worker, or he doesn't really value the company at $250m.

Is he legally allowed to do this and is there any other options I can take?

what can I do to protect myself from something like this happening again.

We would need more details, but it certainly sounds like he is simply ignoring your ownership rights. You should talk with a lawyer and not sign anything or in any way indicate acceptance of anything before doing so. The lawyer can tell you whether you missed anything, but ultimately if someone decides to ignore a contract, there's not much you can do to prevent that.