An organization’s governing board takes on significant responsibilities in the course of its day-to-day operations. Not only do its directors and officers work to develop the company’s business plan and shape the culture of the organization, they make crucial financial decisions and accept legal responsibility for the company.
Dario Nalli, Executive Liability Practice Leader at Burns & Wilcox, explains that a director or officer of a company can be pulled into almost any type of liability claim related to business practices. “As leaders of the organization, senior management endures the consequences if their choices lead to legal action,” he says.
This is particularly true for directors and officers in the emerging tech industry. When you couple the highly competitive, fast-paced tech culture with the industry’s reliance on multiple third-party investors and shareholder accountability, tech entrepreneurs are at an increased risk of Directors and Officers (D&O) claims.
According to Nalli, investing in D&O insurance provides tech entrepreneurs a strategic advantage in protecting their most important assets. “The cost of legal defense when a director or officer faces a claim can be significant, placing both company assets and personal assets on the line,” says Nalli. “Having the right D&O insurance in place helps protect companies from the cost of defending against claims.”
Nalli outlines the following five reasons why brokers and agents should work with their emerging tech clients to secure D&O coverage:
1. Derivative Claims
As start-up capital is often raised through multiple investors, directors and officers in emerging tech face increased pressure to appease its shareholders. If the company does not perform as expected it may face a derivative claim from these shareholders, a common occurrence in the first five years of business. By investing in a D&O policy early on, tech firms may be covered for defense costs incurred from a derivative claim.
2. Executive and Board Recruitment
Bringing the right talent into the board room can make or break a company during the start-up phase. In the tech industry, securing the best often involves persuading entrepreneurs away from large firms. These individuals have a plethora of experience, and often come with extensive personal assets, which can be put on the line should the company face a legal claim. Having a D&O policy provides incoming executive and board talent with peace of mind knowing they are protected should they be brought into a claim.
3. Business Planning
Like any growing company, start-up tech firms have financial obligations to their shareholders. Should the company be unable to meet their projected profit margins and financial obligations, the directors and officers may face a claim related to poor business planning and inadequate return on investment. A D&O policy provides coverage for the significant defense costs related to liability claims and helps the organization avoid going into debt.
4. Patent Infringement/Unfair Business Practices
The fluid nature of tech research and development creates an environment for tech entrepreneurs to build, grow and improve on ideas. However, it also increases the risk of claims of patent infringement and unfair business practices as the patent line is not always clear. A D&O policy helps a tech start-up manage defense costs should they be faced with a regulatory action from the Federal Trade Commission (FTC) or a claim questioning the legitimacy of their product development.
With limited capital during the start-up phase, many tech companies invest in expanding business development in lieu of investing in comprehensive insurance policies. A director or officer facing a claim may be found legally responsible if their existing policy is found to be insufficient. For example, if the company faces a cyber-attack and the cyber liability coverage does not include adequate limits to cover the recovery costs, the shareholders may initiate a D&O claim related to the management’s failure to secure adequate coverage. A D&O policy will help provide financial retribution of any incurred defense costs.
Before providing a D&O policy, the broker or underwriter may seek to examine the company’s financial statements. In absence of this documentation, brokers and underwriters may instead review the company’s business plan, projected financials and capitalization table.
By reviewing these items with their client and considering the facts available to them, brokers and agents will be better positioned to assess their clients’ risk. Additionally, it will help to better develop a policy that may provide adequate limits and sufficient coverage, which will benefit the client.