And you are right, there is potential for negotiation regarding the exercise of dilution protection. Investors don’t want to eliminate or reduce founders/management’s incentive to work. While the founder-VC relationship can seem adversarial, the founders will get the most out of the relationship if they view their VC as an ally rather than a “vulture capitalist.” Thus, open communication like you suggest is invaluable.

If a company needs to raise more funds, due to an unforeseen event (say, spurred by this economy)… then it’s in everyone’s interest to dilute the company, rather than own shares in a broke(n) company.

A VC that owns 20% of a bankrupt company is almost never going to be as valuable as owning 15% of a company that is profitable. When you bring on a VC, you’re expecting to have a funding partner, not someone that poorly acts on their rights.

But, you are right, a lot of start-ups took money like candy (much like in the sub-prime mortgage crisis we’re also in now) and didn’t read the fine print (much less have a team that could understand it). And now the VCs are defending themselves and asking the other shareholders to dilute their shares instead. My point on that angle is, sometimes that isn’t an option… especially as a startup gets closer to market.

By the way, I’m speaking as a start-up owner that has gone bootstrapped so far, not really as someone in a position to be ticked at a VC anyways.

Since this article was rather light on real advice (no offense, you do raise some good points), I’ll give some more advice to startups in this position. If a VC does shoot down the concept of diluting initially… go back to them with a better picture of how dire things are. Obviously a startup doesn’t ever want to dilute… so show your VCs what they’re risking by blocking the dilution.