The ABCs of Directors & Officers Insurance for Startups

As your startup grows, so does your risk. If you’re building an early-stage company, having Directors and Officers (D&O) insurance is important. It helps you protect your investors, board, and leadership team from liability and lawsuits.

About our experts: Vouch is a digital business insurance platform, built by startup founders for startup founders and backed by institutions and investors like SVB and Y Combinator. It’s a platform, not a broker, so they’re there to help you manage, mitigate, and avoid risks.

Below, we asked Vouch Insurance’s Startup Insurance Advisor Team Lead, David Kaufman to answer the most common questions about D&O business insurance.

Common scenarios where a startup founder may need D&O Insurance coverage:

• Legal disputes with stakeholders and founding members
• A member of your leadership team discloses competitor’s trade secrets
• Failure to comply with workplace laws

In short, Directors and Officers (D&O) insurance is designed to protect C-suite officers and board members if they’re sued over decisions they’ve made on the startup’s behalf. But what types of insurance coverage do you need, when, and why?

When and why do founders need D&O?

D&O is designed to protect the personal assets of the people listed as “Insured Persons” on the D&O insurance policy in the event they are sued by employees, vendors, competitors, investors, customers, regulators or other parties, for actual or alleged wrongful acts.

“Wrongful acts” are defined in Vouch’s policy as: “any actual or alleged act, omission, error, misstatement, misleading statement, neglect, breach of duty by any Insured Person.” The most common of these acts include the following:

• Breach of fiduciary duty resulting in financial losses or bankruptcy
• Misrepresentation of company assets
• Misuse of company funds
• Fraud

How is D&O different from Key Person insurance?

While D&O is designed to offer protection for the company and individual directors and officers of the company, Key Person Insurance is a personal lines coverage in which the company is named as a beneficiary.

The intent of Key Person Insurance is to provide the company with time to find a replacement if a key person in the organization passes away. That money can be used to cover the costs of recruiting, hiring, and training a replacement for the deceased person. If the company doesn’t believe it can continue operations, it can use the money to pay off debts, distribute money to investors, provide severance benefits to employees, or close down the business.

What should founders look for and make sure their D&O insurance covers?

There are a few things to look for. First, check the definition of Insured Person on the policy– i.e. who is covered by this policy?

Prior Acts — Vouch’s D&O is a “claims-made” policy, which means that the policy will only respond to claims that are made during the policy period. This is the industry standard for D&O policies.

With that said, it’s important to note whether a D&O policy has a “prior acts date” or a “retroactive” date, which means that the policy can be triggered by “wrongful acts” that occurred before the policy begins (as long as the claim is made against the Company or Insured Person during the policy term).

Major Shareholder Exclusion — Many companies will include a “Major Shareholder Exclusion” into their D&O terms. This is an exclusion that may result in a lower price, but limits coverage in the event of a claim by excluding coverage for individuals that own over a certain percentage of the company (usually 10%). We recommend making sure this exclusion is not included in your coverage.

Can there be conflicts of interest between what board members and investors want in a D&O policy?

There could be conflict, depending on the breadth of D&O coverage the company selects. Typical D&O policies have three insuring agreements: “Coverage A” for losses the company cannot reimburse the director or officer, “Coverage B” for Insured Person losses that can be reimbursed, and “Coverage C” to protect the company itself (usually related to mismanagement of securities). Since these are typically subject to the same policy limit, a claim against the company (Coverage C) reduces coverage available under the other coverages.

However conflicts can often be mitigated by clear declaration of the investors’ requirements for D&O coverage, so directors can select policies that best represent all interests. Individual directors may also consider purchasing their own “Side-A-Only” coverage on a separate policy.*

As your company scales, do you need different D&O coverage? What kind of company milestones require a need to invest more in D&O?

When scaling a startup, the following milestones should prompt the company and its directors to review their coverage and determine if changes need to be made immediately or upon policy renewal:

• Acquisitions: A named insured should check their policy to determine if coverage is automatically extended to new organizations and whether the insurance company needs to be notified within a certain timeframe.
• New investment round: The terms of the funding organization should be considered against the current D&O policy to identify any gaps that need to be addressed immediately or on renewal.
• Company officer becomes a board member of an additional organization: Both the company and the officer should review what activities are/aren’t covered by the officer’s new position; for example serving on school boards, municipalities, and nonprofits.*

When insurers price D&O, what is this based on, and what are some best practices startups can implement before they get D&O, to ensure getting the lowest possible rate?

The price of a D&O policy has a direct relation to several aspects of risk management and can also be related to assets, revenue or capital raised. The following pieces of advice can help a company manage their D&O risk, and could reduce a company’s D&O costs if the practices are visible to an insurer:

• Having experienced legal and management professionals represented on the executive team, board of directors, or consulting the board
• Demonstrating (through run rate, funding terms, balance sheet, and public data) a track of financial health and viability of the company
• “Establishing the independence of a corporation’s board of directors”*
• “Ensuring that directors and officers fully understand the organization’s operations, corporate charter and bylaws, and securities and antitrust laws”*

What are reasons founders could get denied D&O coverage?

There could be many reasons, but here are a few of the most common situations: Prior D&O claims, certain business classifications in highly regulated or in unregulated markets (think cryptocurrencies), or doing business in areas the insurer doesn’t specialize (countries, industry types, etc).

What are the pros and cons of switching insurance providers? When a merger or acquisition is about to happen, what are considerations founders should keep in mind when reviewing their new D&O policy?

Switching insurance providers may help a company find the most appropriate price and coverage terms for their operations. A notable con could be the potential loss of discounts given by insurance providers when their clients have multiple coverages or contiguous renewals.

Regarding a merger or acquisition, a named insured should check their policy to determine if coverage is automatically extended to new organizations and whether the insurance company needs to be notified within a certain timeframe. Many D&O policies extend this coverage to newly acquired companies until the policy expires, if the wrongful act occurred before an acquisition. Upon renewing a policy, the named insured should carefully identify what new organizations may need to be named on their policy.*

Interested in learning more?

Vouch is a partner of Heavybit’s Perks and Discounts Program, which we offer exclusively to members of our portfolio. If you’re interested in joining the accelerator, you can learn more and apply here. If you just want to learn more about business insurance and how to start saving, you can read more about the 10+ lines of proprietary coverage, from General Liability, Employment Practices Liability, to Cyber policies, and apply in under 10 minutes on the Vouch site.

* Information is partially derived from material in or are direct quotes from Commercial Liability Risk Management and Insurance, 3rd Edition, © 2017 The American Institutes for Chartered Property Casualty Underwriters

The information contained herein is used for illustrative and informational purposes only. It is not meant as legal advice. All the information herein is believed to be from credible sources, however state laws, regulations and rules may vary. All content © Vouch, Inc.