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D&O Insurance: Why Startups & Small Businesses Need It?

D&O insurance is an investment in the security of the business you’ve worked so hard to build.

Directors and officers insurance, often referred to as D&O insurance, is one of the least understood types of business coverage.

Because of this, it’s typically purchased by successful established businesses that work with insurance experts who recommend it to them. It’s rarely ever considered by startups and smaller growing enterprises, which typically focus more on securing core coverages, such as general liability insurance, business property insurance, professional liability protection, and workers’ compensation coverage. Most entrepreneurs have never heard of it, and it they have, they don’t know what D&O insurance is or what it does.

This is unfortunate because many startups and rapidly expanding smaller operations could benefit from it. Here’s why.

What is directors and officers insurance?

D&O insurance is a type of business liability coverage. It pays legal defense costs, settlements and damages if the executives and members of the board of directors of a business are sued. It also pays costs related to them failing to meet regulatory requirements. If a business does not have D&O coverage, it’s likely that company directors or officers would be held personally liable for a lawsuit and have to pay any related expenses out of pocket. In some cases, companies kick in to help with some of the costs.

The kinds of lawsuits and claims D&O insurance covers are those related to mistakes made by executives or board members when running a company. For example, a chief executive officer makes statements when trying to get funding from prospective investors that an actual investor later believes to be fraudulent and sues the CEO over them. D&O coverage would likely cover expenses related to fighting or settling the claim. Another example: If the people on a company’s executive team fail to take action on a regulatory requirement and they’re fined or sued for non-compliance, D&O insurance would provide a level of protection.

Check it out: The founder of an app used by celebrities is sued because of statements he made while getting funding for the business.

What D&O insurance covers

A company’s leadership team gets most of the credit, and earns the most money, when things go right in the workplace. However, when they make mistakes and things go wrong, they get the blame and are often sued by groups or individuals who seek retribution. Being a company leader is a double-edged sword, making them more vulnerable than anyone else in an organization. Sure, the payouts are high when things are good. But they can be completely wiped out, and more, if someone on the leadership team makes a mistake or demonstrates poor judgment and are sued. Add to this the fact that litigious people can sue if they think something was handled incorrectly even when it wasn’t. Legal bills for borderline or frivolous lawsuits can be significant and cause serious financial harm to an individual and the business they work for.

Types of D&O Insurance

According to the Insurance Information Institute (III), there are actually three main components in most of these policies, broken down into what are known as “sides.”  They are:

  • Side A: Covers a corporation’s directors and officers when a company refuses to or is not financially able to indemnify the individuals.
  • Side B: Covers an organization when it indemnifies the directors and officers. Once an organization indemnifies the individuals, this side reimburses the organization. 
  • Side C: Extends the coverage to both the directors and officers and the entity itself. This one is a little more complicated. When the directors and officers and the insured organization are named as co-defendants in a securities lawsuit, this does away with the disputes of coverage allocation. It’s also known as entity coverage.

Policies like these typically cover claims like shareholder suits pertaining to how a company or stocks are performing, pollution, failing to abide by regulations and even cyber liability, as a few examples.    

However, it’s important to look into each policy, as there can be many exclusions, such as fraud or personal profiting.

The value of D&O insurance for startups and growing businesses

When it comes to startups and newer businesses, companies are typically led by the entrepreneurs or visionaries who founded them (think Mark Zuckerberg at Facebook) or, if those people don’t have experience in business or an interest in it, a group of executives brought in for the purpose of taking on key leadership roles. Some companies use a hybrid of this, having experienced business people support and advise the founder or founders.

No matter who leads a startup or rapidly growing new business, having D&O insurance is critical. If the firm is headed up by a founder or group of them, it’s likely that they don’t have much experience in business. This makes it more likely they could make mistakes that could result in lawsuits, or failing to comply with regulations. It’s why it can be a good idea for companies with founders as leaders to have D&O insurance to protect them.

For companies that hire experienced people to fill leadership positions, or provide guidance to founders, D&O insurance is also something they likely need. While experienced executives are less likely to make mistakes that could result in a breach of fiduciary duty, investor issues, compliance problems or other things that could result in litigation or fines, senior business people are unlikely to accept a job with a company that doesn’t provide them with D&O insurance protection. Without D&O coverage, they’re putting themselves, their families, personal savings and assets at risk for someone else’s business, which doesn’t make sense.

One other reason a startup may need to get D&O insurance is if they receive funding from a venture capitalist (VC) or venture capital firm. If that’s the case, a startup may be required by their VC contract to secure D&O coverage. 

How much does D&O coverage cost?

The price of D&O insurance is dependent on many factors, including company industry, size of the operation, risks faced and experience level of the people insured. The cost of this coverage, typically several thousand dollars a year, is relatively small when you consider the size of the risks it helps mitigate.

How to buy directors and officers insurance

Owners of startups and other newer businesses often think they’re too small to require D&O coverage. However, they have fewer financial resources than larger enterprises. This makes them — and their senior employees — more vulnerable to lawsuits. Many end up being forced to close down because of legal issues. 

Think of it another way: Startups and small businesses that are growing rapidly can’t afford to put their leaders at risk or have them become distracted because they’re worried about getting sued, even for frivolous reasons.

D&O insurance is an add on to your business insurance coverage. If you own a start-up or fast-growing company, and think you may need D&O protection, speak with your insurance agent or representative at your insurance company, to find out if it’s the right move for you. If you’re in the process of launching a startup, make sure D&O coverage is included as part of your online insurance application process or discussion with an insurance expert.

In the end, purchasing D&O insurance is an investment in the security of the company you’ve worked so hard to build and grow.

D&O insurance for non-profits

Similar to for-profit organizations, non-profit organizations that have directors and officers need to have D&O insurance. It helps protects the personal assets of directors and officers from law suits arising from their actions and decisions as directors and officers of the non-profit organizations. In many cases, directors and officers of non-profit organizations may not even realized that they are held accountable personally for the actions of the organizations.

In many cases, D&O insurance helps attract talents to serve as directors and officers for non-profit organizations. It helps them feel confident in their actions and decisions. D&O insurance covers the defense costs, settlements and judgments associated with claims against the non-profit organizations.

How Much does Non-Profit D&O Insurance Cost?

Non-profit D&O insurance isn’t very expensive. The median cost of D&O insurance for non-profit organization is $80 a month, or $960 a year. If you want to save money, make sure you shop around with a few companies to compare quotes before buying. Working with a digital broker like CoverWallet is a good way to compare several quotes in one place conveniently.

D&O insurance vs. E&O insurance: How are they different?

D&O insurance covers the directors and officers of an organization against claims and law suits believing that they are negligent in their duties as directors and officers of the organization. On the other hand, E&O insurance protects employees of an organization against claims and law suits believing that they are negligent in their acts and performance of duties resulting in errors and omissions.

They are both important. If your business provides services to customers, you need to make sure to have E&O insurance to protect your business and your employees from E&O claims and law suits. If you business or organization is big enough to have directors and officers, you need to have D&O insurance to protect them from law suits arising from duties as director and officers of the organization.

D&O insurance vs. professional indemnity insurance: How are they different?

Professional indemnity insurance, or more commonly referred to as professional liability insurance, covers claims against all professionals believing that they are negligent in the performance of their duties resulting in bodily injuries or property damages. On the other hand, D&O insurance protects the personal assets of directors and officers in claims relating to their actions and decisions while working for the board or the organization. D&O insurance doesn’t cover bodily injuries and property damages.

>>MORE: The 5 Best D&O Insurance Companies

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