If Gen AI Is a Bubble, Here's How Investment Managers Can Stay Protected

In January 2025, the Gen AI investment thesis was pressure-tested when DeepSeek, a Chinese startup, appeared to have developed a bona fide ChatGPT competitor at a small fraction of the cost. Nvidia’s stock price swooned, along with many other tech companies. As of this writing, the narrative around DeepSeek remains hotly contested and Nvidia’s stock price has mostly recovered. Anyone who says that they know exactly how this story will play out is probably trying to sell you something.

A rising AI tide lifts all AI boats. Conversely, to modify the overused but still useful words of Warren Buffett, when the AI tide goes out, you find out who is swimming AI naked. So, as it goes valuation-wise for the OpenAI whale, so it goes for pre-profitability Gen AI startups clinging like remora to the big overall transformative growth narrative.

For many private investment managers in the tech sector, avoiding investments in Gen AI is not a real option. Valuation concerns accompany every market cycle. Also, in early-stage investing, you are supposed to kiss a bunch of AI frogs before you meet your AI prince and get your AI happy ending (i.e., a ridiculous multiple on your initial investment). If you don’t pick some AI losers along the way, you’re not doing it right.

Still, even a middle-case scenario—somewhere between McKinsey and Acemoglu—could result in a lot of AI losers. When once-promising and well-funded companies go belly up, litigation often ensues. And when that happens, the board seat you took when your firm invested looks less like a spot at the buffet table and more like a place in the line of fire.

But—good news! With a well-constructed insurance program, you can breathe easy even if some of your portfolio companies experience significant financial issues or bankruptcy. Let’s look at how you can stay protected.

Portfolio Company D&O Insurance

The first layers of protection come from portfolio company indemnification and insurance. Indemnification is always the initial line of defense. But if the company is unwilling or unable to indemnify a director, D&O insurance can step in. This coverage will perform when directors are sued in shareholder litigation and/or in bankruptcy. In shareholder derivative and bankruptcy scenarios, Side A coverage is especially important to ensure that dedicated insurance is available to the directors.

Portfolio company insurance is important to have. When taking board seats, investment managers often specify a minimum amount of insurance they expect companies to maintain. However, private company D&O insurance programs are typically relatively small. This usually makes good sense—the D&O risk profile of a private company held by a small group of sophisticated institutional investors is considerably lower than that of a publicly traded company.

But issues can crop up when the size of the insurance program doesn’t keep pace with exponential growth in revenue and funding. Also, as a director, you are probably not going deep into the terms and conditions of your portfolio company insurance coverage. You want additional protection in case there is a coverage gap or a downside scenario that exceeds the portfolio company limits.

The Umbrella: Outside Directorship Liability Coverage

The next buffer is outside directorship liability (ODL) coverage. This coverage is typically a component of general partnership liability (GPL) policies purchased by private investment managers, including venture capital and private equity firms.

ODL coverage sits excess of portfolio company D&O insurance. This means that the portfolio company insurance pays first. Also, ODL coverage only kicks in if the portfolio company is unable or unwilling to indemnify a director.

When those criteria are met, however, ODL coverage provides a very nice additional layer of protection. This risk is most prevalent in the context of bankruptcy (when the portfolio company lacks assets to indemnify directors) and in shareholder derivative litigation (when the portfolio company may be barred by law from indemnifying directors for settlements).

Conclusion

Regardless of the future trajectory of Gen AI, everyone can agree that there will be both big winners and many losers in the sector. Well-crafted insurance coverage—both at the portfolio company and investment manager level—can mitigate the downside legal risks of serving on the boards of losers. Finally, when you pay for this insurance year after year, you want the umbrella to open on rainy days. Your insurance advisors need to provide expert and robust claims advocacy to ensure your policy performs.