Even for startups it makes sense to carry insurance coverage against potential losses to the business, or claims that may be made against it. Unfortunately we live in litigious times and being small - and being right - doesn't mean someone won't try and come after you with some kind of claim. Obviously you try and run your startup with the proper attention to operating within the law and with the right advisors to counsel you - insurance coverage then backs you up if needed. What are some of the key areas to consider and what kind of coverage can you get?
Directors & Officers Insurance (D&O):
D&O coverage is a "must have" once you start to have people acting in Board member (Directors) and senior executive (who may or may not be Officers) capacities. The people who act in these capacities for you are going to do their best to help guide and direct the company - but given that state laws can make you personally liable for the things you do in these roles you need to provide some coverage for these folks.
A professional investor such as a VC will carry insurance for their partners who become your Board members - but you still need coverage for other Board members and the Officers, and the company needs to be the beneficiary (which it is not with VC's own coverage). Usually a company indemnifies Directors and Officers when acting in their official capacity - and the insurance coverage insures you have the capacity to follow through on this indemnification if any claims are made. If you are asked to become a Director or Officer of a company don't ever agree to this without checking that you have both indemnification AND company has the insurance coverage in place or you could be personally exposed. In exchange for your expertise and help this is the least you should expect.
What kinds of things are covered by D&O insurance? Being sued by a disgruntled stockholder who believes that he or his class of stock has been disadvantaged by a business decision to take a new round of funding, for example.
Typical levels of D&O coverage are $1 million to $3 million. Cost is maybe $5,000 for $1 million or $10,000 for $2 million of such coverage. For a small company this will seem expensive, so you and your Board and Officers need to consider the level of coverage carefully. $1 million is probably fine where you are pre-Series A, but $2 million or more is better when you've raised a full Series A or later.
Employment Practices Liability Insurance (EPLI):
Often bundled with Directors & Officers policies, this insurance covers you against claims made by employees or former employees for things like age discrimination, unfair dismissal, failure to pay sales commissions or other compensation, etc. As always, the best insurance is to operate with clear and consistent policies and procedures. But I've personally seen situations where, for example, a salesperson has been terminated for poor performance and a significant time later has come back and claimed commissions for deals closed after he left and where he was not involved in the transaction or in any efforts leading up to it. In such a case, even if you are 100% right, the cost of defending the action brought against you can be very high, so why take the chance. For a small, 15 person company, $500,000 of coverage with a $10,000 deductible may only cost $700 a year. Well worth it!
One key thing to remember. Many policies, including D&O and EPLI, are what's called "claims made". That means the policy has to be in effect when the claim is made, NOT specifically when the alleged event took place. So its no good having an EPLI policy in place when you fire a salesrep but having it lapse before he comes back and sues you a year later. You won't be covered. The good news - if you don't have this policy in place now then getting it will usually cover you for prior acts (unless you already know you're getting sued!).
With D&O, if you sell the company, ALWAYS get a "tail policy" in place. This covers you against claims made through the end of the statute of limitations period, usually 6 years after the completion of the sale, and long after your company has been subsumed into the acquiring business. Cost might be about 3x the annual D&O premium but is a "one-off" usually paid out of sale proceeds.
Another thing. As soon as any claim is made - or someone even starts the dialogue about it - tell your broker and bring him/her into the loop. Don't go off and hire a lawyer etc. Your insurance carrier will usually take over the defence of any claim and use the specific legal expertise they have on retainer to help you.
Let me know if you need some recommendations for good insurance brokers!
