Timing, D&O Insurance, and Your IPO (or M&A Event)

A question I often hear from private companies planning to go public is, “When should I start morphing my D&O insurance program if we’re thinking about an IPO?”

My answer is always: if possible, consider ramping up your D&O insurance efforts during the D&O renewal cycle that takes place the year before your IPO. This allows you to make a few easy – but strategic moves that can yield significant benefits later.

In this post, I’ll explain further what those moves are. Of course, if you can’t address these points pre-IPO, it’s not the end of the world.  This post, however, is about optimizing your coverage.

Higher Limit Warranty Statements

As a private company facing an IPO, consider raising your private company D&O insurance limits to between $5 million and $10 million.  This is not because that’s the exposure per se; rather, you would do this to avoid providing a warranty statement for your full primary (first) layer of insurance at the time of the IPO.

As you know, large insurance programs typically have multiple sequential layers (e.g. primary $10 million, then $10 million in excess of the $10 million, then $10 million in excess of the first $20 million, etc.) with different carriers. Every time you put in place a new layer of insurance that you didn’t have before (e.g. every new million over the first few millions you had in place the previous year), you have to make a warranty statement to the insurance carrier for the new layer.

The warranty statement is a representation to the insurance carrier that the directors and officers know of nothing that is likely to give rise to a claim. In my experience, such a statement is always more likely to be true sooner than later.

Consider that as you get closer to the IPO, and as the world is aware you are closer to an IPO, it’s all too common to become the object of “hold-up” (or real) litigation.  Once you become aware of something that is reasonably likely to give rise to a claim, you have to disclose it to the insurance carriers. And, for clarity, they will exclude the disclosed item from future coverage. Definitely not something you want to have happen to your brand new public company D&O policy.

Also, consider the natural insurance carrier reaction if you are sued within the first year after your IPO (this happened twice in 2013).  Of course, the carrier is going to look at the warranty statement and ask: Did you really not know that the gnarly claim you just tendered was going to pop up?

They are asking because an untruthful warranty statement could create a defense to the insurance carrier’s having to pay the claim, or at least create the start of a tough negotiation. It’s better all around if the was-the-warranty-statement-accurate question does not arise for the first $5 to $10 million of insurance.

Some will ask, “Given this logic shouldn’t we buy the same amount of limits pre-IPO as we plan to buy post-IPO”? There may, in some very limited circumstances, be reason to do this. However, in most cases, it’s probably not the highest, best use of a pre-IPO company’s dollars.  Also, in some cases, that amount might not even be available to the pre-IPO company.

Plan Ahead: Is M&A a Possibility?

Filing an IPO often communicates a message (whether intentional or not) that you’re up for sale. And sometimes companies in fact sell themselves rather than go public.

If your company is acquired, the insurance issue here is the tail policy. I explained the importance of a tail policy in M&A in a recent post here. In general, you’ll want to place a tail policy that ensures coverage exists for post-closing claims related to activity that took place pre-closing.

A board of directors that may have been happy with the $2 million in D&O insurance limits as a private company might actually want a little more in limit for the tail policy.

Post-closing suits can be tricky, and one never really knows if the acquiror will step up (or be solvent) a few years down the road. Please note that in the current market, it is extremely difficult to raise insurance limits after you have an M&A deal in the works. To have the option for a higher limit tail policy, you will have had to place that higher limit before M&A rumblings began.

As a side note, it’s generally expected that the acquiring company will assume the indemnification obligations of the acquired company, but this doesn’t always happen. This is another reason you’ll want to be ready to place a robust D&O insurance tail policy.

One more thing …

It’s also important to remember that the entire insurance risk management program — and not just the D&O insurance side of things — needs to be ready for public company scrutiny post-IPO.

You don’t want to have gone public, and only then find out that your cyber liability coverage is inadequate, your international insurance placements are out of compliance and the like. These are good items to address well before you have filed your first S-1.

Start Preparing Now

As a private company considering an IPO, it’s important to be strategic during the D&O insurance renewal cycle before your IPO. Eighteen months out is a good time to start thinking about these matters and getting everything into place.

For more information on D&O insurance considerations prior to an IPO, check out Woodruff Sawyer’s latest downloadable resource, "IPO Track 2014.” It has a ton of information, and is on in a tablet-friendly format to boot.