8 Reasons Private Companies Need D&O Insurance

Directors and officers coverage is a staple insurance product for public companies – but do private companies need it as well? There are many instances where a private company will decide against it; however, there are eight good reasons that private companies should consider D&O insurance.

1. Attracting New Directors

D&O insurance makes board seats more attractive. Having a good D&O insurance program helps convey that the private company is being managed and operated in a way that resembles a serious public company.

2. Venture Capital Requirements

Some venture capital firms require their portfolio companies to purchase D&O insurance as a condition of the venture capital firm’s investment.

3. Emerging Risks

Private company D&O insurance may be able to respond to newly emerging risks. For example, years ago, it would have been rare to hear anyone cite the need to defend against illegal insider trading as a reason for private company D&O insurance. With the emergence of secondary sales platforms for private company stock, this has changed.

4. Regulatory Exposures

Private companies are subject to government regulations. A prime example of government enforcement against private companies is the U.S. Department of Justice’s vigorous enforcement of the Foreign Corrupt Practices Act. Paying the cost of an attorney to defend an officer (or director) against a government enforcement action is expensive. Private company D&O insurance policies can help with these types of expenses.

5. Bankruptcy

Private companies sometimes go bankrupt. In bankruptcy, creditors can sue directors and officers. When a corporation is insolvent, only D&O insurance stands between creditor suits and the personal assets of the directors and officers.

6. Mergers & Acquisitions.

If you’re considering M&A, it’s best to purchase the D&O insurance as soon as possible. Current directors and officers will want to be indemnified if they are sued after the deal closes; however, an acquiring company may not be willing to do this. And even if the acquiring company says it will provide indemnification, it will be meaningless if the acquiring company goes bankrupt. For more on how to mitigate risk in M&A, read my recent post on the topic.

7. Shareholder Lawsuits

When a private company’s number of shareholders (without board representation) grows, the risk that a disgruntled shareholder will file suit against the directors and officers also grows. This is especially the case if a company has to do a “down round” of financing. It’s also a risk of M&A environment. D&O policies can be especially helpful in funding the litigation defense costs of these types of litigation.

8. IPO Considerations

Last but not least. if your company is considering going public, consider placing D&O insurance while it’s still private. Doing so can build a relationship with public company insurers. (This is nice, but not always necessary in the highly competitive market for IPO D&O insurance.) Another reason a pre-IPO company might buy D&O insurance is to avoid having to make any warranty statement for at least the first layer of insurance the company intends to rely on after it goes public.

2 Considerations When Placing D&O Insurance

As a private company purchasing D&O insurance, consider the following:

1.    Warranty obligation: Any company purchasing a new layer of D&O insurance, whether it’s the company’s first million dollars of coverage or a new excess layer, must make a warranty to the insurance carrier that the company knows of nothing that is likely to give rise to a claim under the “new” layer. As a company matures, unfolding events make these warranties harder to make. For this reason, companies sometimes buy D&O insurance sooner rather than later.

2.    EPL coverage “discount”: Private companies can bundle the purchase of D&O insurance with related lines of insurance, such as employment practices liability insurance (“EPLI”). Since the bulk of the insurance premium is often related to the EPLI part of the policy (employment-related suits being a higher risk than D&O claims), the D&O insurance included in the policy is often seen as an economical way to shift risk away from the company and its directors and officers.

In a future post, I’ll address the considerations that private companies should assess when researching and purchasing D&O insurance.