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If you’re a startup founder, directors and officers (D&O) coverage may not be on your radar yet. Many entrepreneurs opt for “bare minimum” insurance to mitigate overhead costs. You likely want to invest your funds in building out your product or service — and winning those important first customers.
Inadequate insurance, however, can place your early-stage venture at risk. Here’s how D&O coverage can protect your reputation, personal finances, and bottom line.
D&O coverage is like a safety net for company leaders. If someone sues you for a decision you made while managing the company, this insurance can help cover legal costs (defense costs, damages, awards, settlements) and other expenses. It’s a way to protect your executives and board members from personal financial loss.
As a startup founder, you wear multiple hats. You’re creating and launching a groundbreaking product or service, while also juggling operational details like banking and insurance. The sheer speed at which you work and make decisions brings both success and risks. Here are five reasons to explore D&O coverage:
You’re building a strong leadership team to help drive the business and grow. D&O insurance is a crucial selling point to get expert leaders and board members to sign on. The more experienced they are, the more likely they will demand D&O coverage as a condition of employment. They’ve been part of organizations that have had to deal with risk exposures. They know this coverage is critical to protect them individually as well as the company.
Though workplace claims typically fall under employment practices liability insurance (EPLI), they have the potential to cross over into D&O. Here’s why: Startups often do not have expertise across all business functions. Due to budget constraints, you may not have funds to hire an experienced human resources (HR) employee. A court can hold directors and officers liable for the decisions they make regarding the handling or response to employment-related claims.
Before you tap an engineer to oversee HR — or hire an entry-level employee to manage job applications and employee benefits — consider the risks. If the person responsible for HR activities is not aware of hiring and firing pitfalls, you and your company can end up with claims that could result in costly fines or worse.
Startups often feel pressure to get a product or service to market. If they knowingly launch an incomplete product, investors will not be happy and can sue. Additionally, a customer class action lawsuit can result for any product or service that doesn’t deliver as promised.
Sometimes, the vision doesn’t work out for startups, as any serial entrepreneur knows. Instead of having a planned public launch, they close shop. They sell their assets. Even after the business closure and sale of assets, the startup’s officers are not free and clear from obligations. They still need to have coverage for any claims that happened prior to the entity’s closing. Tail coverage, an extension of the D&O insurance, serves this purpose. Without tail coverage, the defunct company’s officers’ personal assets are at risk.
The CFO or COO often takes on risk management responsibilities. However, they are juggling multiple projects, so they likely have blind spots to different exposures across the company. That knowledge gap itself is a risk exposure. Eventually, a dedicated risk manager will be on your team. Until then, you’ll want a third-party risk advisor to help you identify risks and ways to mitigate them.
You may now be on board with obtaining D&O insurance or expanding your existing coverage. Here’s what D&O underwriters are looking for when determining the extent and price of coverage:
It’s important for startups to make sound, focused investment decisions. D&O insurance is one of those priority investments for early-stage companies. As with all insurance, you may never need it, but having it can make the difference for your bottom line and long-term viability.
Want to learn more?
Find Scott on LinkedIn, here.
Connect with the Risk Strategies Management Liability team at MLPG@risk-strategies.com.
About the author
With over 15 years of broking experience, Scott Taylor develops executive liability programs for startups, small businesses, and middle market companies. He specializes in D&O insurance, EPLI, fiduciary liability, cyber liability, professional liability, and crime coverage.