If you’re the founder of a growing startup, there’s a good chance you’ve heard of “directors & officers insurance” but might not understand what it is and what it’s intended to cover.
Technically speaking, D&O is a type of liability insurance, that will reimburse settlements or defense costs that result from lawsuits alleging a breach of fiduciary duty. In the event of such lawsuits, the most powerful people in your company tend to be the ones that are under the most scrutiny and pressure. That’s why it’s common to see lawsuits or claims being filed against them related to a decision or wrongful act that was made by a company’s top executive or board member.
Some of the common types of claims that are filed against company leaders include breach of contract or fiduciary duty, mismanagement, noncompliance with laws and regulations, misuse of company funds, misrepresentations of company assets, and failure to comply with workplace laws.
In the event of a claim filed against your leadership, your D&O policy will kick in to cover legal costs and potential settlement amounts. One of the best and most highly publicized examples of why D&O insurance is so important is Elon Musk getting sued by Tesla investors last year over things he said on social media. Tesla ended up paying a $20 million settlement, and you can be certain that their D&O policy responded to protect Musk from financial damages arising from the lawsuit.
Even in the case of bankruptcy, the insurance will protect company’s leaders and investors. As such, a properly tailored directors and officers insurance policy can serve as a risk transfer mechanism – transferring personal liability away from your company and onto your insurance carrier – including significant legal cost and settlements.
Why Founders Need D&O Insurance
Founders of smaller startups might see the aforementioned Tesla story and say “well that won’t happen to me.” The truth is that while large corporations certainly have more shareholders to consider, they also have something a growing startup doesn’t have; resources to fight or settle a lawsuit filed against their directors and officers. In contrast, for early stage companies D&O insurance can provide a financial security net in the event of a worst-case scenario lawsuit.
As a founder there are other parties (beyond yourself) worth considering – your team and your investors. For both, D&O insurance can protect assets from exposure, especially in the event the company has run out of funds to pay for legal costs and settlements.
When building out a team, founders may find it difficult to attract top talent without D&O insurance because many leaders will not consider joining your team or board without this financial protection in place. For example, if your startup takes on debt it can no longer re-pay, the bank may sue the company’s leadership team. In this case, D&O insurance may provide coverage, offering protection for yourself and your executive team and removing the need to dip into company assets to cover legal and settlement costs.
Furthermore, founders will find that most investors require D&O insurance as part of a term sheet for a funding round. Investors require D&O insurance as a means for managing risk across their portfolio of investments. In the event of a claim of fiduciary mis-management, your investors will want this coverage to be in place both to protect their investment (you and your startup) as well as themselves and their firm.
Startups are known for being fast-paced businesses in which decisions are being made quickly. The most successful ones tend to have decisive leaders who follow their intuition to take advantage of vital business opportunities to stay a step ahead of the competition. Having D&O insurance allows startup leadership to be aggressive and react quickly and decisively without having to worry about the potential risks involved in every move they make.
There’s certainly no denying that most startup founders have a lot on their plates. In the fast-paced world of startups, being decisive is inherently important and the speed at which you make decisions could dictate the rate of your success. As a founder, the risks you decide to take and the risks you decide not to pursue matter, a lot.
Buying the proper business insurance is the best way to transfer a lot of the risk that comes with making many of your financial decisions. It can allow your company’s best and brightest to do what they do best without having to worry about the potential financial fallout that could arise out of even the smallest misstep or mistake. D&O insurance provides a startup’s executives with the protection they need to bravely and decisively lead the company on the path to fast and sustainable growth.