When an investor invests an amount in a startup company exchange for equity, how do they protect themselves from being significantly diluted by a larger investor? And is that even an issue?
It certainly can happen. There are a few things I've seen early-stage seed investors do to protect themselves from dilution:
In general, angel investors will be diluted by new rounds of funding, but the investors and founders will be affected equally by new rounds of money. What it comes down to is working with the founders and helping them make the company succeed- sometimes more investment means you get a smaller slice of the pie, but the overall pie will get a lot bigger.