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The short answer is maybe.
The long answer, from my perspective both as a founder who lived through getting insurance as well as an investor helping navigate our portfolio companies through insurance, requires some short background theory. The purpose of insurance is to protect the value of what you have built in the event of certain events: someone hurting themselves in your office, a hacker stealing your code, an irate shareholder suing the company. In the event one of these many possible events occur, rather than paying for the cost of these events out of the company’s bank account, your insurance company pays for them. In return, you pay your insurance company on a regular basis regardless if anything occurs or not.
The key words are “protect value.” A startup that is little more than a sketch on a napkin has no tangible value. There is nothing to insure.
The office
The first time a new startup will need to get insurance is not because they suddenly have something of value to protect. It’s because they moved into a space that is requiring protection. I’m talking about office space. The owner of the office space will want their property (their value) protected from activities that occur within your business.
If your startup is still in the pre-revenue, the smallest required GL policy is all you’ll want to get.
Accidents happen even in tech businesses. Back in my startup days I was moving a large server from one rack to another and accidentally dropped it on one of my fingers, almost severing the tip. A quick hospital trip and insurance claim later, all was better, but the example serves as a reminder that far worse accidents can still happen within our relatively quiet office spaces.
The type of insurance you’ll need is a general liability and property insurance. General liability and property insurance protects against third party property or bodily damage. It’s not that expensive and can be considered the base layer for all other commercial insurance products.
If you’re curious at what all those other products are, just look at the list of exclusions in your general liability policy. You’ll notice that everything from employee practice claims, emotional distress, pension liability, pollution, acts of terrorism, cybersecurity to nuclear energy hazard are excluded. The list of exclusions is really long.
If your startup is still in the pre-revenue/pre-MPV stage, the smallest required GL policy is all you’ll want to get. You’re not protecting the value of the company — you’re protecting the minimum necessary value for your landlord. You do that by adding the property owner as “additional insured,” an insurance industry term for who else, other than your company, can lay claim to the insurance money.
The client
For B2B companies, the next time you will encounter insurance needs may come at your first big sale. Big companies like to have services agreement where they are protected from you, in the event you do something you shouldn’t. That’s typically done by purchasing Errors and Omissions insurance (E&O). Like GL, it’s usually not a terrible price and, frankly, having it is a cost of doing business. As with your general policy, your client(s) will likely want to be a named additional insured on your policy.
The venture capitalist
Any startup that receives an institutional investment (i.e. venture funding), especially if the investor takes a board seat, will likely be required to get directors and officers (D&O) insurance.
D&O insurance protects the VCs individually and their investment funds from the activity of the board of directors. In other words, the board of directors as it regularly reviews and updates everything from the strategic plan, to the CEO’s compensation, will make decisions. In due course of those board decisions, it’s possible they could upset shareholders or other stakeholders to the point of legal action. D&O insurance is meant to protect the interests of board members. Hence, why D&O insurance is a prerequisite for investors who will join your board.
Lastly, later stage funding rounds may require the company to take on key man insurance on the Founder/CEO and possibly other key executives. Key man insurance is a form of life insurance where the beneficiary is the company rather than the individual’s estate.
There are of course many other insurances out there, but these are the four a tech company will typically face in its early years.
PS: I’ve left off worker’s compensation insurance, mainly because my experience is in the US, where workers comp and health benefits are entirely different, and in Ontario where software development is exempt from WSIB. I’ve also left off cyber insurance, which is still relatively new and few if any startups have it.
Sarah’s take
Christian did a great job covering the types of insurance products that startups need. You’re rarely going to get a term sheet pulled during legal diligence if you don’t have coverage, but as the value of your startup grows, the value you have at stake from an uninsured incident grows.
This is a relatively linear equation with your balance sheet. By incorporating your startup, you as the founder take on a limited liability position, which prevents financial losses to the amount invested in the corporation. The exception is when you accept debt which includes a personal guarantee, extending your legal obligation to include your personal assets.
In general, there are six main inflection points at which you should reflect on your insurance needs (alongside a trusted legal or financial planning advisor who understand startup needs specifically — don’t ask your estate planner).
Those inflection points are when you:
- Incorporate your business
- Add employees to payroll
- Move into a new office
- Close a round of funding
- Sign clients
- See significant revenue growth (necessitating a conversation about coverage limits).