Why should start-up directors consider D&O insurance?

Start-up directors will often take risks for their business venture to be successful. If there were no risks, the financial rewards would be small. Unfortunately, in the pursuit of success, this can often lead to legal disputes arising from a wide range of sources, such as customers, regulators, shareholders, employees, and competitors.

A lengthy legal battle can do more damage to a start-up business because they won't have the resources and will be highly dependent upon a small number of individuals in the business. Without established legal and HR teams, defending a claim, or dealing with a regulator's investigation can be complicated and time consuming.

Common causes of D&O insurance claims against start-up directors can include investor misrepresentation, breaches of regulation, insolvency claims, HR issue, breaches of law, and intellectual property claims from competitors.

Example D&O claims made against start-up businesses

Below we've identified example of why startups should consider directors and officers insurance to protect both the company and the individuals from a range of costly legal disputes:

1 Intellectual property

A senior manager left a company to start his own business, and his previous employer later accused them of taking proprietary software, creating unfair competition and trademark infringement. Although the individual was later found to be innocent, the costs to defend the claim were excess of £300,000.

2 Shareholder actions

Following a startup investment round, the board was found negligently for providing inaccurate financial statements which the investment decision. After the business failed, they sought to claim compensation of two million pounds against the directors.

3 Employment related issues

A director was accused of sexual discrimination, harassment and failing to promote an employee. The case went to employment tribunal, but the claim was ultimately settled out of court, with insurers agreeing to settle the demand for compensation made against the individual for £70,000.

4 Regulatory investigations

The Financial Conduct Authority (FCA) brought criminal proceedings against the CFO for misrepresentation of the financial standing of the company. The case went on for many months and the cost to defend the allegation was excess of £500,000, and the individual was later struck off the register.

5 Health and safety

A construction company's board of directors were held responsible for not having sufficient controls in place, and breaches of health and safety legislation, which was found after an accidental death of an employee. Both the company and directors were fined over £1 million and liable to pay damages to the families.

Start-up D&O coverage

To understand what D&O coverage will protect against, we recommend you read our comprehensive guide. The need to arrange cover will typically come from experienced directors wishing to protect their personal assets or has been specified by an investor or advisor to ensure a safety should the worst happen.

The cover is commonly purchased for companies which have raised money from private equity or venture capital. It will sometimes be a prerequisite to a funding round giving vide the necessary security to the investors.

Legal actions made against individual directors and/or against the company can be expensive to defend. The ability to mount an appropriate legal defence can sometimes mean the difference between a successful or failed start-up.

When should your start-up buy D&O insurance?

Cover can be purchased straight away and is typically one of the first insurance covers bought by startups. As opposed to professional indemnity insurance, which is typically purchase before you start trading.

If you have not submitted a monthly cash flow forecast for the first 12 months and a pitch deck or business plan, insurers will seek to apply an insolvency exclusion.

Insurance underwriters will require an appreciation of how much headroom you have in the business to meet your ongoing financial obligations. Claims arising from insolvency are a significant exposure to start-up businesses and it is recommended that the cover is included. Especially, if you have raised money from investors.

The cost of D&O insurance for start-ups

The answers unfortunately depend upon several factors, with the most important being:

• the industry you operate
• the amount of money you have raised
• exposure to the USA
• your ability to meet your ongoing financial obligations.

For most start-up businesses that have raised less than £2 million, you can expect to spend between £1,500 and £2,000 annually. However, this will exclude a several more challenging sectors such as financial services, fintech, mining, exploration, and sports clubs.

D&O insurance premiums will be calculated upon the information provided within each individual submission.

Typically, you will be requested to complete a proposal form, provide a pitch-deck or business plan, and a cash flow forecast for the next 12 months. Alternatively, if you have a positive net worth and made a profit in the last reporting period, insurance premiums can start as low as £345 annually for a £1 million limit.

Businesses should discuss their specific requirements with their insurance broker. If you would like to enquire further about the different options available, please contact us on 0345 625 0711.