The Ins and Outs of Directors and Officers Insurance
How much can a claim against your board or C-suite cost your startup? The cost of damages from a D&O claim can range from six-figures to losses as high as $18M. According to the trade publication Business Insurance, Directors and Officers (D&O) claims are also on the rise.
The financial stakes for startup founders are considerable and are not uncommon.
Making high-level business decisions as part of running a fast-moving startup exposes C-suite officers and board members to risk. They may find themselves named in a civil claim against your company, placing the business entity and their own personal assets in danger. Directors and Officers (D&O) Insurance can help shift that risk from your company and company leadership to your insurer.
To attract top talent and investment, you need to be able to prove that your company has the ability to absorb that cost without putting C-suite officers or your investors’ assets in danger.
What Does Directors and Officers Insurance Cover?
D&O can cover the costs of legal fees, judgments, and settlements for board members and company leadership in the event of lawsuits related to their specific duties as part of the company. This includes but is not limited to regulatory issues, alleged failure to disclose, claims of negligent corporate governance, mergers, and acquisitions.
It also can cover claims of a breached fiduciary duty leading to financial losses or insolvency. For example, if a stakeholder, including customers, suppliers, or government regulators, believes the board decision caused a loss, they can take action like start an investigation or issue fines.
When one of these claims arises, often the company as a whole and one or more of the board members are named as the respondent. Whether or not the claim has legal merit, defending against it is costly. The high cost of settlements and judgments means you need to be covered by insurance.
Could Investors and Founders Want Different Things in a D&O Policy?
There can be a conflict of interest between founders, board members, and investors when it comes to selecting a D&O policy. Depending on how your policy is structured, there are typically three distinct aspects to how D&O insurance transfers risk: side A, B, and C. Side A and B can cover the individual board members in slightly different ways. Side A reimburses the directors and officers in instances where the company cannot cover those costs. Side B allows the company to recover the costs when it can cover a board member or officer’s legal expenses.
However, Side C, also called Entity Coverage, helps protect the company itself from losses often related to securities claims and negligence. Even though Sides A–C transfer risk in different ways, they are all part of the same policy. If a suit is filed naming the individuals and the corporate entity as co-respondents, the policy limits still apply. When more funds are used to cover the company, that generally means there are fewer funds left over to cover the individuals.
These conflicts of interests must be negotiated between the parties, however; fortunately, individual directors can purchase a separate “Side-A-Only” policy to protect themselves further while leaving more of the shared D&O policy to cover the company.
What Is Key Person Insurance, and Is It Included in My D&O policy?
Key Person and D&O insurance transfer risk in two distinct ways and are not considered the same policy.
The sudden death of an essential member of the company can lead to uncertainty about the company’s future. Stakeholders, especially investors and employees, may have concerns about whether or not the company can survive. Whereas a life insurance policy typically names a spouse or child as the beneficiary; in a Key Person policy, it’s the company who is the beneficiary.
Those benefits can be utilized in one of two ways. First, the funds can be used to recruit, hire, and train someone to fill the vacant position. If, for whatever reason, no one can be found to assume those duties, the funds can also be used to fulfill financial obligations to lenders, investors, and employees before dissolving the company.
What Doesn’t Directors and Officers Insurance Cover?
Unless explicitly stated otherwise in your policy, there are several common restrictions contained in many D&O policies. While lawsuits can be brought against the company for various reasons, D&O typically does not apply to situations that fit more appropriately under another policy—whether you have that policy or not. For example, D&O usually does not cover data breaches (Cyber) or discrimination claims (Employment Practices Liability).
The purpose of D&O insurance is to cover the financial fallout from unforeseen events. If a claim is already underway prior to the policy effective date, you’re aware it’s coming, or the incident that spawned the lawsuit happened before the policy was issued, it falls under “Prior Acts.” While there are some policies that may cover prior acts, those are the exception, not the rule.
Some D&O policies have a “Major Shareholder Exclusion” clause. This excludes coverage for individuals who own more than a certain percentage of the company. Be mindful of this when reviewing what is and is not covered by your policy. Such exclusions should be avoided when possible.
When Should I Get Directors and Officers Insurance?
If you approach an investor or a potential board member, they may ask you upfront how extensive is your D&O coverage. Having the policy ready beforehand lets your investor know that you take risk seriously and are prepared to protect their assets.
Venture capitalists and investors expect to see a rate of return, and if your board makes a decision that threatens that return, they have the option to sue. With a sufficient D&O insurance policy, they can still expect to recoup costs despite what financial troubles your company faces.
Having a D&O insurance policy in place makes your company less of a gamble and, therefore, a more attractive investment.
What Are Considerations Founders Should Keep in Mind When Reviewing Their New D&O Policy Before a Merger or Acquisition?
As founders are 16 times more likely to get acquired than go public, a unique need they'll have for their D&O policy is the ability to purchase Runoff Coverage. Runoff Coverage works by providing a period of time after the acquisition date (ranging from months to years, depending on your options) to report claims that occurred on or before the acquisition date. More importantly, many acquiring companies require the purchase of Runoff Coverage as part of the transaction. You don't want something like that standing in the way of a done deal!
How Much Will It Cover and How Much Does It Cost?
The answer depends on the level of risk your company and board face. As your company grows, so does the risk. As you gain new investments, acquisitions, launch products, and reach new milestones, your insurance needs continue to change. Check your policy to see if you still have sufficient coverage as your company continues to evolve. You need to know if policy adjustments need to be made immediately, within a specific timeframe, or when you renew your insurance.
Insurance costs are impacted by risk, so factors like your industry or location can affect your premiums. As with most other coverage, there are ways you can mitigate risk and lower your overall costs. For example, one way to lower your premiums is to choose more experienced and knowledgeable members for your board and executive team—which is easier to do if you approach them with your D&O policy already in place. If you have a history of financial stability and growth, that can also lower your rates. Speak with an insurance advisor to optimize your plan and keep costs under control.
Why Choose Vouch?
The Directors and Officers (D&O) Insurance market is changing. Some legacy insurance companies have even stopped offering it as an option.
As the underwriter, Vouch has more flexibility to address the needs of startup founders and can work with your startup to customize your D&O policy for the type of industry you are in and the types of risks that you face. Not only can you get D&O from Vouch, but you can do so quickly. Apply, and you could have your policy in place within 24 hours.
Additionally, Vouch offers aspects of D&O insurance you’re unlikely to find anywhere else. For example, with Vouch, you can purchase cap table coverage which covers the cost of disputes concerning ownership percentages and equity. Vouch also has options to cover the legal expenses of alleged copyright violations.
When it comes to D&O, exclusions are also important. What’s worth noting is that Vouch’s D&O policy does not exclude coverage for a startup if an investor sues the insured under a D&O policy, and also has board seats. It's a new coverage rarely seen in the marketplace.
To attract the best C-suite officers and board members, you have to be sure that their personal assets are protected should a lawsuit, merited or otherwise, arise from decisions they make on behalf of the company. Directors and Officers Insurance is essential to a startup company's growth as that company recruits and maintains a highly effective leadership team.