Directors & Officers Insurance Coverage: D&O Explained | Embroker (2024)

Who Is Directors and Officers Insurance For?

While D&O insurance is not an absolute must-have for every single business, it should be strongly considered by businesses and organizations that could be accused of financial mismanagement.

For example, if your business owes millions to creditors, D&O insurance will help protect the leadership and company in general if it ever goes under. Many times, creditors will want to blame the company’s directors and officers for the business’s inability to pay them back, which is a situation in which D&O insurance would come in very handy.

Also, if a company is looking to attract top-tier executives and leadership to the organization, getting D&O insurance is a good start for that process because a vast majority of top executives will not even consider joining a company that lacks this type of coverage.

Smaller, private companies and startups are often under the incorrect impression that they do not need D&O insurance, believing that their chances of getting hit with a claim are relatively small, but that simply isn’t true.

In fact, a 2016 survey performed by Chubb shows that more than 25 percent of private companies experienced a claim over a three-year period and the ones that did not buy D&O insurance reported an average loss of nearly $400,000.

Therefore, it can be concluded that any private or public company that has a board of directors should also have D&O insurance. Some of the exposures that directors and officers are most vulnerable to include regulatory actions, misrepresentation allegations, securities litigation, and breaches of fiduciary duties.

D&O insurance fills the gap that general liability and umbrella insurance do not cover when it comes to protecting company board members and executives. Nonprofits should also have it since these types of organizations are managed by a board of directors as well.

Why Do Startups Need D&O Insurance?

Directors & officers insurance is the coverage that is probably most consistently connected to and mentioned when talking about startups, especially startups that have received or are about to receive venture capital funding. Why is this? It’s because most venture capital and private equity firms will insist that a startup gets D&O insurance before they approve the funding round.

They do this because as investors, they will be joining the startup’s board, so they are basically guaranteeing that the startup will be protecting them and their assets by having a directors & officers policy in place.

For startups, having a good D&O policy gives them the ability to pay for unanticipated litigation, which can be extremely expensive. Even if you have received funding, your startup still might not have the budget needed to handle these types of legal costs, especially if the claims are complex and take months or years to resolve.

Does that mean that if your startup doesn’t have a board, then it doesn’t need D&O insurance? Absolutely not.

Even if your startup is organized in a different fashion, it can still face the same types of risks that a VC-funded startup with a board of directors faces. Remember, you don’t need to have a board of directors in order for your startup’s leadership to be sued for things such as contractual disputes, breach of fiduciary duty, wrongful termination, and a failure to comply with federal and state regulations and laws.

When people hear about lawsuits being filed against company board members, they immediately think of complex schemes, wrongful acts, and criminal activities, but in reality, most claims filed against corporate leaders are related to everyday events.

Hiring and dismissing employees and working with third-party vendors or suppliers are two examples of everyday business activities that most wouldn’t consider risky. However, these are the exact types of activities that result in the majority of D&O claims.

Furthermore, there are other benefits that come with having a preferred D&O policy that aren’t specifically tied to claims and being able to pay for lawsuits.

Having a D&O policy also enables you to attract and hire top talent, especially at the executive level. Top candidates will almost never accept a role at a company that doesn’t have a D&O policy that protects its leadership.

Even if they believe strongly in the company and its mission, a vast majority of corporate leaders do not want to put their personal assets at risk, no matter how attractive the opportunity appears.

Venture Capital Firms and D&O Insurance

As we’ve already mentioned, VCs want your startup to have D&O insurance before committing to funding it because they want to protect their personal assets as future members of your board and leadership. However, there are other reasons behind why a majority of VCs insist on directors and officers insurance.

The protection that directors & officers insurance provides gives investors guarantees that your business is serious about its growth. D&O claims can be incredibly expensive and knowing that the startup you’re investing in has coverage and will not be paying legal fees and potential settlements out of pocket shows investors that the company’s leadership is serious about stability and growth.

Of course, venture capital and private equity firms not only ask the companies they invest in to buy D&O insurance, they also buy it themselves when putting together an insurance program that protects their assets.