5 ms·

Could someone who has a better grasp of corporate/securities law explain to me why the following is illegal/impossible: conspiring with an investor to get a sma

Could someone who has a better grasp of corporate/securities law explain to me why the following is illegal/impossible: conspiring with an investor to get a small follow-up investment round with an inflated valuation, thus reducing the dilution of the $375k? For example, after the initial $500k from YC, you get your VC buddy to invest $50k at 0.1% for a total valuation of $50M, diluting the $375k to a mere 0.75% stake. This feels fraudulent to me, and there’s probably some language that YC uses to prevent this, but would is this otherwise illegal?

ReaLNero 5y ago
I doubt PG is hastily rewriting all of YC's investment agreements as we speak to resolve this loophole! This very much depends on the contract that was signed between the company and YC. Most likely, the founder has a fiduciary duty to represent the stakeholders' financial interests. By maliciously diluting their equity, this would breach the contract, opening up the founder to lawsuits. A very relevant case is that of Eduardo Saverin's equity in Facebook getting diluted [0]. [0]: https://en.wikipedia.org/wiki/Eduardo_Saverin#Career https://en.wikipedia.org/wiki/Eduardo_Saverin#Career
chemeng 5y ago
Pro-rata rights prevent this, but it's an interesting question of whether it would be illegal.
aripickar 5y ago
It's less that it's illegal/impossible and more that it's not in the interests of the company in the long run. Say you do that, then what? If you screw over the seed investors, they are probably are going to tell the series A (and B, C, etc) investors that you screwed them over, and its going to be a lot harder to impossible to raise the next rounds. Plus who would want to invest in a company when the founder already screwed over the last investors. The only way that it could work is if you are able to grow the company indefinitely without raising more money (See Toptal). Basically, you are exchanging all the goodwill and ability to raise in the future for a small percentage of equity. Not a great trade, if you ask me.

ReaLNero 5y ago

I doubt PG is hastily rewriting all of YC's investment agreements as we speak to resolve this loophole! This very much depends on the contract that was signed between the company and YC. Most likely, the founder has a fiduciary duty to represent the stakeholders' financial interests. By maliciously diluting their equity, this would breach the contract, opening up the founder to lawsuits. A very relevant case is that of Eduardo Saverin's equity in Facebook getting diluted [0]. [0]: https://en.wikipedia.org/wiki/Eduardo_Saverin#Career https://en.wikipedia.org/wiki/Eduardo_Saverin#Career

chemeng 5y ago

Pro-rata rights prevent this, but it's an interesting question of whether it would be illegal.

aripickar 5y ago

It's less that it's illegal/impossible and more that it's not in the interests of the company in the long run. Say you do that, then what? If you screw over the seed investors, they are probably are going to tell the series A (and B, C, etc) investors that you screwed them over, and its going to be a lot harder to impossible to raise the next rounds. Plus who would want to invest in a company when the founder already screwed over the last investors. The only way that it could work is if you are able to grow the company indefinitely without raising more money (See Toptal). Basically, you are exchanging all the goodwill and ability to raise in the future for a small percentage of equity. Not a great trade, if you ask me.