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So you founded a startup. Money is tight and challenges abound. Among the many issues you must address is a business plan that protects you, your investment and your company. This means thinking about insurance.
Purchasing insurance is a difficult proposition for any startup. To founders, insurance is an immediate cost that presents only attenuated benefits. Most startups struggle with capitalization and may view insurance as a luxury purchase they simply cannot afford. Many startups will either forego or postpone buying insurance. But this is usually a mistake. Insurance is the most cost-effective way for a startup to transfer risk away from the company and its founders. Furthermore, potential clients and investors may require that a startup carry insurance or at least may view an insured company as a safer partner.
Once a startup begins thinking about insurance, the question becomes what type(s) of insurance should it purchase? To answer, one must understand the risks that the company and its founders realistically face. Based on my experience as an insurance attorney dealing with claims that have become contentious, it is common for a startup to buy insurance that is ultimately valueless, since the coverage—while broad—does not apply to the company’s actual risks.
For example, one of my clients bought a significant amount of property and liability insurance. Yet the biggest risk the company faced was employment claims by the workers it employed. This would have made employment practices liability insurance (“EPLI”) a wise investment. Unfortunately, the company did not carry this kind of insurance, and its premiums guarded against risks that were either non-existent or too remote to justify the investment. Meanwhile, the company was exposed to a risk that, in retrospect, was fairly obvious and could have been avoided. This was an expensive mistake.
Founders themselves must decide whether the investment in specific insurance makes sense given the company’s budget and risk-management goals. In making this decision, it is important to work with an experienced insurance broker. But I should emphasize the word “with”—insurance decisions should not be left to a broker. Making insurance decisions requires that founders carefully evaluate their company’s risk profile and whether it makes sense to allocate scarce resources to protect against those risks.
What follows are some basic questions that founders should ask themselves when thinking about their company’s insurance needs. While this list is not exhaustive, it can serve as a useful starting point.
1. Does your startup have personal or real property, or does it take possession of significant client property?
If the answer is yes, it is worth thinking about buying first party property insurance. While there are several kinds of property insurance policies, these policies most typically protect against the risk of physical damage to property you possess, along with the risk that your business operations will be interrupted after property is damaged. Risk profile is key. If your startup involves people working remotely on a laptop, and the company owns or rents minimal personal or real property, there may be little reason to buy first party property insurance.
2. Is there a chance your startup injures someone or damages their property?
If yes, you should consider purchasing commercial general liability (“CGL”) insurance. This is the basic coverage carried by most companies, and it protects against three categories of risks. One of these categories—“personal and advertising injury”—I discuss in the following section. The other two are liability for “bodily injury” or “property damage.”
If your company is placing products into the stream of commerce or engaging in conduct that presents a risk of physical injury to third parties, you probably need CGL coverage. Likewise, if your startup has operations that could damage another’s property, CGL coverage will be a good idea. Again, your risk profile is key. If your startup is internet based and you sell no products, then carefully consider whether a claim for “bodily injury” or “property damage” justifies investing resources into a CGL policy.
3. Does your startup face soft intellectual-property claims?
If yes, it is worth exploring both CGL coverage and a specific media-liability policy. As mentioned above, the third category of risk that CGL policies protect against is called “personal and advertising injury.” Without getting into the weeds, “personal and advertising injury” under a CGL policy traditionally includes, among other things, coverage for soft IP claims. These include claims for things like trade disparagement, along with trade dress, slogan or other forms of advertising appropriation. However, many insurers now use exclusions to eliminate coverage for soft IP claims. For this reason, it is also worth exploring coverage under a media-liability policy or its equivalent. Media-liability policies typically cover the kinds of soft IP risks that used to be covered by a CGL policy. They also cover risks that were never traditionally covered by a CGL policy but which many companies facing soft IP claims want to guard against. When thinking about soft IP coverage, it is important to work with an experienced broker who can sort through CGL and media-liability policies to ensure they are tailored to your company’s needs.
4. Does your start-up face hard intellectual-property claims?
If yes, it is worth thinking about an intellectual property liability policy. These policies typically cover hard IP claims, like patent, trademark, or copyright infringement. There can be significant overlap between coverage under an intellectual property policy and a media-liability policy. So you should work with a broker who understands these nuances.
5. Does your startup face cyber risks?
If yes, it is also worth considering a cyber policy. These are new insurance forms that have become widely available only recently. Cyber policies typically protect against claims by third parties for data loss, breach or theft, and liability claims that are related to computer or internet use. They also cover claims by your own company for software damage, data loss or other computer-related losses. For startups working in the tech space, cyber policies may be the single most important piece of insurance. Interestingly, cyber policies tend to be quite affordable. And they usually provide broad coverage. Because these are new products, quality can vary among insurers. Your broker should understand the differences between various cyber policies and should help you purchase the one that is best suited for your company’s needs.
6. Does your start-up hire employees or independent contractors?
If yes, it might be necessary, depending on the number of workers you hire, to consider EPLI coverage. Because many EPLI policies exclude coverage for violating state and federal wage laws—which is one of the most significant risks an employer faces, particularly in a state like California—you should look at EPLI policies that include coverage for these claims.
7. Do the founders need to protect themselves personally?
If yes, you should consider Director’s and Officer’s (“D&O”) liability insurance. D&O policies typically protect founders against claims for any “breach of duty” allegedly committed while running the business. Coverage under a D&O policy is typically quite broad. If the founders are worried about being exposed to personal liability for acting in their corporate role, purchasing D&O insurance presents a great way to protect founders individually. D&O policies have an added benefit: Most extend coverage to the company itself. This is an often overlooked aspect of D&O insurance that may add significant value to the company’s overall risk-management strategy.
Before investing your startup’s limited resources into insurance, think carefully about the realistic risks your company faces. This will provide greater peace of mind, a better return on your purchase, and it will help avoid the kinds of insurance mishaps that are far too common among startups.