Monday, February 19, 2007

D&O Insurance: the Startup Challenge

It continues to surprise me how little attention some investors pay to directors and officers insurance. Once D&O insurance makes its way into the investment documents (usually as a commitment by the company to obtain insurance post-closing), it is almost never mentioned again. It's understandable, mind you (insurance is right up there with optical add-drop muxers as compelling cocktail conversation); but it's not a terrific practice.

Recently, I was asked to join the board of a terrific startup. As part of my homework, I asked to see the company's D&O insurance policy and the application itself. Why? A potential director always wants to insure that a company has indemnified him/her against any costs that director may suffer should a lawsuit be brought against the board. But because most startups are cash constrained, D&O insurance is the usual way to ensure that funds are available to honor that indemnity.

The insurance application is maybe the most critical part of the insurance policy. It contains representations and warranties about the Company, its share structure and other matters such as the Company's employment practices, changes in management, financial statements and the like. If any of these representations or warranties are inaccurate or materially misrepresent facts, any claim a director may make could be denied, or the entire policy could be rescinded altogether.

Applications for policy renewals are equally important. The information on the application is the information most likely to change from year to year in any company,particularly in a startup. Larger companies actually hold day-long interviews with their insurers at renewal time to ensure that all changes are properly reported and coverage is not at risk.


The insurance application is often left entirely in the hands of the company controller or the CFO. Very little review or oversight of the process occurs. I urge my clients (and you) to ensure that there is a check and balance to this process - either a review by the CEO and the audit committee of the board, or a regular report on the annual renewal process. Why wait until your insurer rejects a claim to examine the issue more closely?

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