What is startup D&O insurance and why do I need it?
Directors and officers make tough decisions every day. That’s why directors & officers insurance (D&O) protects them while doing their job. D&O insurance policies protect a company’s individual directors and officers from claims based on their decisions made while acting in his or her corporate capacity.
Coverage provided under a D&O program may vary from policy to policy. However, all generally provide coverage for board members and executives and offer protection for their personal assets. D&O can also provide protection for the company by reimbursing the corporation after indemnifying a director/officer. It can even indemnify the company itself in certain situations!
The mechanics of a D&O lawsuit
Suppose angry investors come after you, the CEO of a company. You have a hot startup and the investors claim that you misused the funds they’ve invested, pushing their return on investment back. They may even attempt to sue you personally. Sure, your company’s bylaws may protect you…but they may not. This is where D&O insurance steps in.
Understanding D&O insurance coverage
D&O is a unique form of insurance in that it has three “sides.” These three main clauses (Side A, B and C) provide different aspects of coverage:
Side A: This provides coverage for losses of an insured person (director or officer) in which the company cannot indemnify him or her. This may be because the company refuses to indemnify this person pursuant to the company’s bylaws, or most commonly, it can’t indemnify him or her because of insolvency.*
Side B: While Side A covers the individual, Side B provides coverage for the company for its indemnification obligation to its directors and officers.
Side C: This is known as entity coverage and ensures there is coverage for the business itself in certain situations.
*In most cases, Side B and C are subject to a retention while insolvency Side A claims are not.
Uniquely startup D&O insurance examples
Example 1: Startups are, by nature, much more agile and less risk-averse than other companies. Decision-makers (directors and officers) often make decisions quickly and might not have the time to evaluate all potential risks. Thus the potential for a D&O claim is naturally high for startups.
Example 2: Let’s say you’re looking to secure funding to get your business going. In many cases, the investor(s) will require you to have D&O insurance, especially if they are placing someone on the board. This ensures that these individuals’ assets will be protected against claims while they are acting in their capacity as a Director or Officer.
Example 3: Let’s say your investors allege you’ve made fraudulent claims in your investor deck. A D&O policy would provide coverage for the defense costs associated with this claim. A good policy will cover costs until final adjudication deems the allegations to be true.
Example 4: You have a young company that has raised capital. Although you never anticipate failure, it’s certainly a possibility. If something were to happen and you can’t achieve the stated return on investment on time (or even worse, are going under) you could be exposed to an action to reclaim whatever investors can of their investment. A D&O policy would protect the Directors’ and Officers’ personal assets, as well as the company itself, from such claims.
Example 5: D&O insurance can be a useful recruiting tool to bring industry leaders to your team. If knowledgeable and successful people know they’ll be able to make decisions on your business’ behalf without facing a personal lawsuit, they are much more receptive to joining the team.
What cost can I expect to pay for a D&O policy?
On a very broad range, D&O policies can cost anywhere from $3,000 to $7,000 in premium for every $1M in coverage.
This is a rough estimate on pricing and the premium is based on a number of factors:
- Class of business: some industries have higher risks for D&O claims (FinTech, healthcare, venture capital firms)
- Investor base: who is on your cap table; do you have many outside investors or are you mostly self-funded?
- Capital raised to date and future funding plans: the more capital raised, the greater the risk. The higher the limit, the higher the premium.
- Financial performance: companies that indicate success in the long run will be more favorably underwritten than those who are struggling. D&O underwriters are very interested to know that the projected breakeven will occur during year 2 and profits continue to grow thereafter. If there’s a big runway due to a recent raise, underwriters may be more lenient on this point. (This is a big talking point for us when approaching underwriters for your quotes! Most VCs don’t want to see profitability that quickly, so it’s a catch 22 that we must clear when quoting.)
- Limit of liability: While a $1M policy may cost between $3,000 and $7,000, a $2M policy may range from $5,000 to $13,000 and so on, as the limits continue to rise. In general, as the limit goes up, the rate per million dollars of coverage will start to go down.
What else do I need to consider?
Now that you know what a D&O policy is, why you need it, and what the approximate cost might be, here’s some other points to consider:
- If you’re just starting out, an insurance company would like to see your pitch deck/investor deck. This gives them an idea of the nature of your company and your roadmap.
- Financials: underwriters are most interested in audited financials. But if those are unavailable, they will often work with unaudited statements and even pro forma statements where necessary.