While this list is definitely not exhaustive, I wanted to briefly shed some light on a couple of the reasons why startups need insurance and should look into coverage options regardless of where they are in their life cycle.
1. To strike a balance
“Risk-averse” is probably the last phrase anyone would use to describe the startup community. The whole point of getting into this game is to disrupt, right? And that’s a beautiful thing. It’s what pushes society forward and generally improves the human experience.
It’s incredible how much risk a startup can take on. I know this is an extreme example, but Paypal broke something like 40 state and federal laws when it began its operations! By doing so, they completely reinvented the purchase experience. When you’re taking on entire industries and shaking up the status quo, something’s bound to go wrong and someone’s bound to sue you eventually. It probably won’t be federal or state regulators, but you’ll still have a black hole of time-wasting paperwork and legal fees on your plate.
When things go awry, most startups will fold depending on their current revenue-generation abilities and where they are in the funding cycle. This is because they simply don’t have the cash to defend themselves. Most startups also don’t realize that even if the claims brought against them are totally absurd and have no chance of success, they still have to pay their lawyers to deal with it! The beauty of having insurance is that these legal fees (and most other related expenses) are covered by a good policy.
2. To attract investors
Obviously institutional investors are not risk-averse either, but they do work very hard to control and mitigate risk as much as possible when making investments. That’s basically their entire reason for doing due diligence on your company. One characteristic that can attract investors or tip the scale in a potential deal is how well the company recognizes the necessity of risk management. Founders that think far enough ahead to purchase insurance definitely seem more legit to investors because they show a certain level of sophistication and foresight, both qualities that are required if an awesome idea is going to grow into a flourishing company.
3. To keep investors happy
As I just mentioned, its not necessarily all about the idea…investors do everything in their power to eliminate risk from the equation. One of the ways in which they do this is by requiring companies to get certain types of insurance coverage. In fact, a representation requiring Directors and Officers insurance is essentially a boilerplate term for institutional rounds these days because it directly protects the VC. But depending on the type of company, you may be required to have Errors and Omissions, Property, and General Liability coverage as well.
4. To keep customers happy
Your investors won’t be the only ones demanding proof of insurance. Many of your customers will demand it too, particularly if you’re in the B2B space. And when I say B2B, I really mean that as generally as possible. It doesn’t matter if you’re selling tablet-based software to hospital outpatient programs, a novelty product to SkyMall, or your consulting expertise to advertising firms…more often than not, your customers are going to want some kind of liability coverage in place. And while we’re on the subject…when you start hiring and want to move into that nice new office, your landlord will require proof of insurance too!
5. It’s illegal not to have it!
While that statement isn’t entirely true, it is true about Worker’s Compensation coverage. One of the most common misconceptions about insurance in the startup world is that you don’t need worker’s comp coverage until you have “employees.” Founders usually go by the title “founder” or “co-founder” and tend to think that the management-focused title actually changes things. In reality, “employees” for WC purposes include anyone on the payroll. So if you’re taking salary, you need worker’s comp!
I know that insurance is probably the last thing on most founders’ minds. I mean, you’re building a company here. You can’t be bothered with this nonsense! But the reality is this: if all goes well, one day you’re going to be a super legit company that’s constantly hiring and expanding. People sue companies with momentum and visibility. The more customers you get, the more orders you process, the more employees on-boarded, the more room for screw-ups.
It’s important to prepare for these things early on so you’re not caught off-guard when your company takes off.