What is Startup D&O Insurance?
In this blog, we’ll cover what D&O insurance is, why it’s necessary for businesses, and how the D&O insurance needs for startups differ from more established companies.
What is D&O Insurance?
Directors and Officers Insurance (D&O) is a type of liability insurance that focuses on protecting a company’s senior management from lawsuits related to carrying out their roles at the business. This can include lawsuits against the company itself, or against individual executives (“directors and officers”). These suits might be filed by employees, vendors, shareholders, or other third parties.
If a lawsuit is filed naming one or more directors and officers, a D&O policy ensures that the cost of resolving the suit does not endanger their personal assets.
D&O insurance is often included as part of startup management liability insurance packages, but can also be available as a standalone coverage.
What does D&O insurance cover?
While specific policy details may vary, D&O insurance typically covers the costs related to resolving the lawsuit. This can include anything from legal fees for defending against the suit to penalties or settlement payments if the suit is lost or settled out of court.
Some of the most common lawsuits covered by D&O relate to:
General mismanagement, or lack of corporate governance
Financial losses at the business
Misuse of company funds or assets
Misrepresentation to investors of the company’s assets or overall health
Failure to follow applicable laws, including employment law
What does D&O insurance NOT cover?
Some common exclusions in D&O policies include:
Lawsuits related to bodily injury or property damage
Lawsuits relating to mishandling of a company benefits plan (this coverage is usually sold as a separate product, Fiduciary Liability Insurance)
Lawsuits related to alleged activity by members of the senior management team outside their roles at the company
Lawsuits between executives covered by the policy
Actual findings of crime or fraud
This list is not exhaustive, and there can be variation in what individual products do or do not cover.
Why businesses need D&O insurance
If a business is large enough to have a management team, then D&O insurance is a must-have. There are two big reasons for this: risk reduction, and raising money.
The first reason is pretty self-evident: buying insurance for a specific risk reduces the chances that the risk will negatively impact the business. In this case, the risk is that a person or business entity might file a lawsuit alleging misdeeds by the management team. Even if the lawsuit were ultimately found to be groundless, defending themselves in court could still cause the targeted person or company to rack up significant legal bills. A D&O insurance policy can recover any losses resulting from a covered lawsuit.
The second reason relates especially to businesses looking to raise capital: many investors require a company to have D&O insurance before they’re willing to provide financial backing. Investors want assurance that their funds will be used to grow the business (and their potential returns), not be burned up in possible legal costs. Additionally, investors may require it for their own protection. It’s common for an investor to join the portfolio company’s board, and without D&O insurance their assets could then be at risk in a lawsuit against the company.
How is D&O for startups different?
Just like more established businesses, startup businesses need to have D&O insurance (especially as they prepare to fundraise). However, traditional D&O underwriting guidelines can make it difficult for startups to get the necessary coverage . The biggest obstacle? How traditional D&O products evaluate risk.
D&O products designed for large, established companies tend to assess a business’s risk based on factors like historical revenue, balance sheet quality, number of employees, and how long the company has been in business. This is a problem for startups, which are generally small, recently established, and may not have any revenue yet. Under traditional underwriting guidelines, startups are often flagged as high-risk, making coverage very expensive (if they’re even offered coverage at all). This can lead to startup companies being priced out of D&O policies, or needing to go to the non-admitted market to purchase coverage.
While the high-risk assessment might make sense for the kind of company it was designed around - if a company were in business for ten years with hundreds of employees and little to no revenue, it would certainly raise questions about its management - it ignores that startups are a different kind of entity. For young companies still building their products and business, a small team of recent hires and no revenue doesn’t mean the organization is poorly run; it just means it’s new.
What startups need from a D&O insurance policy
Startups need D&O insurance products that provide the coverage they need, at a price they can afford. This means products that assess risk differently than traditional D&O aimed at established companies.
For example, at Boost we tackled this problem by building a risk assessment algorithm that considers a startup company’s institutional backing. When a VC firm is considering whether to back a startup, the firm has access to a huge amount of information related to the startup’s business and practices - and generally goes through it with a fine-toothed comb.
If a startup is included in a top-tier investor’s portfolio, then it’s reasonable to conclude that the startup has a viable business proposition, access to funds and mentorship from the VC management, has a larger potential to succeed - all things that make their risk profile acceptable in a D&O portfolio. This alternate assessment allows us to offer startups significantly lower rates for D&O and similar coverages than traditional insurance products.
Why offer D&O insurance for startups
For businesses that provide commercial insurance, offering D&O insurance geared at startups can be a strong growth opportunity. Providing insurance specially tailored to startups’ needs allows you to build relationships with early-stage businesses that can grow as they do. For example, while a startup might start with D&O, as their business grows they’ll soon need a combined management liability product that includes D&O along with Employment Practices Liability (EPL), Fiduciary Plan Liability, and cyber liability coverages, which will protect the directors, officers, managers and the entity from governance, finance, benefits and management activities.
As your startup customers mature into growth-stage companies, their insurance needs are likely to increase even further. Having a business relationship in place positions you for future upsell and cross-sell opportunities.
Ready to add startup D&O insurance to your lineup? Get in touch today to get started.