This happened to me 6 weeks ago. I'm now happily employed at another (slightly more stable) startup with good work and a better situation.

Trust me, any employee would be happier to be in a stable and improving startup than in one that's going downhill anyway. If they're a dev with startup experience, they'll have no trouble finding a new job and will be better for it.

Don't worry, just be honest and open with them ASAP. The worst thing you can do is keep them in the dark.