A common question asked regarding insurance in the startup space is ‘what do I need and when do I
need it?’ The answers vary based on revenue, clients, and number of employees, but the most common ones are outlined in the Lumen blog, 5 Insurance Inflection Points for Insurance. As time passes, it warrants a revisit to add a company’s last inflection point: the Acquisition! In this month’s blog, the inflection points through a startup’s journey are reviewed in addition to what is needed post-acquisition.
Inflection Point: Adding Big Time Board members
Coverage to consider: D&O
The bigger the name or net worth of the individuals on your board, the more likely they will want personal protection. This is code for Directors & Officers (D&O) Insurance.
Inflection Point: Receiving Institutional Funding
Coverage to consider: D&O and Key Man Life
If you raise institutional funds, your lead VC will likely be on the board. You will also be required to carry a few million dollars of D&O as part of your term sheet. They may also require Key Man Life, especially for a high power CEO or technical co-founder. Reference Lumen’s prior blog: Key Person Life: Your VC Wants Key Person Life On You and Why It’s Not ‘Weird’.
Inflection Point: Signing a Commercial Lease
Coverage to consider: General Liability, Workers Compensation, Commercial Auto, Commercial
These are common requirements in a lease. See Lumen’s prior blog on this for more details: What You Need to Know about Commercial Leases: Common Insurance Requirements..
Inflection Point: Hiring Lots of Employees
Coverage to consider: EPLI
Bringing on a slew of new employees can lead to increased exposures on the HR side. This may include employment practices related claims such as discrimination or sexual harassment. If you use a PEO, it may include Employment Practices Liability Insurance (EPLI), but be sure to get clear on this coverage at this inflection point.
Inflection Point: Landing Large Client Contracts
Coverage to consider: E&O, Cyber, Commercial Crime
In general, the larger the organization, the larger the legal & risk management teams. This means your contracts might have specific requirements. Reference prior Lumen blog: Too Busy ‘Crushing It’ to Run That Contract By Legal.
Inflection Point: The Acquisition
Coverage to consider: D&O, EPLI, E&O, and Cyber Tail Coverage
Funded startups have two possible outcomes: success or failure. 99.9% of the time success will be in the form of an acquisition. It is assumed coverage will roll up into the acquiring company’s program, and all policies can be cancelled at that point. JUST A SECOND THERE, PROFESSOR!
This is a critical step in the lifecycle, and liability does not necessarily end when the docs are signed. Since some claims can take time to bubble up, there is often a clause in the term sheet to require some of the claims made policies to provide tail coverage for years after the acquisition. Here are a few common ones:
- D&O Tail – is the most common requirement. Most startup founders, execs and board members will want this, even if it is not required by the acquiring company, since their names can be listed on lawsuits made prior to the acquisition. The acquiring company will often require this up to 6 years post-acquisition. Reference prior Lumen blog: D&O Tail Coverage – Tips for the Acquisition for more details on what this means, cost and other tips on how to navigate this before, during and after an acquisition.
- EPLI Tail – This can often be included on your D&O policy or as a stand-alone policy, but either way it is important to highlight. Lawsuits often arise from bitter employees post acquisition. Perhaps an employee’s shares did not vest, or they were terminated, losing all their shares. The intent here is not to diminish legitimate claims, but it can be suspicious to receive a demand letter referencing a wrongful termination or sexual harassment years in the past now that the execs have some coin in their pockets. If a PEO provides EPLI, it may be a good idea to ask how coverage will be affected post acquisition.
- E&O and Cyber Tail – This request is a little less common, but we have seen an uptick of these requests in 2018 and 2019. Since E&O and Cyber are often combined on one policy form, these will be referenced together. Both can come back to haunt a startup. Hacks are often not detected for months or years after they occur. According to this 2018 Cost of a Data Breach Study sponsored by IBM Security with research independently conducted by Ponemon Institute LLC, it takes an average of 266 days to identify a breach. Depending on the sophistication level, legal counsel, and hold back clauses of the acquiring company, this might be a request from in the term sheet. Most of the time the policy is going into runoff or putting in a 2 year tail here to match the hold back clause. This can be in lieu of or in conjunction to the acquiring company’s existing coverage. It is good to question how coverage will be affected as it gets rolled up into the acquiring company’s program.
In summary, there are several inflection points in the startup lifecycle. Even when the acquisition is
complete, liability is not over. It is wise to consult your insurance broker and keep them in the loop at each inflection point. Here is a review of some good inflection points to discuss with your broker:
- Adding big time board members
- Receiving institutional funding
- Signing a commercial lease
- Hiring lots of employees
- Signing a large client contract
- The acquisition