Advice for Startups That Fail to IPO and Have Insurance Concerns…
Though many tech entrepreneurs dream of taking a company public, the reality is very few companies (particularly in Austin) go public. Recently, in Austin we had Sailpoint go public and Phunware do a merger into a publicly traded company (count it) but that’s about it. Anand Sanwal, co-founder and CEO of CB Insights, puts it bluntly in a CNN Tech article , “less than 1% — will go public.”
For years it has been said, “90% of startups fail.” However, I read a Fortune article recently highlighting research from Cambridge Associates. They determined the failure (defined as 1X return or less to investors) rate is more like 60% for Venture-Backed Startups.
If this is true, roughly 39% of venture backed startups will likely have a successful (more than 1x return to investors) exit. Even the ones who ‘fail’ can still result in an acquisition, so what do you need to know from an insurance perspective during and after an acquisition?
This blog is not designed to answer all your questions about insurance and ERPs during an acquisition. However, it will give you some context so you can ask the right questions and make a good business decision.
Occurrence vs Claims Made Policies
Know which of your policies are occurrence based and which ones are claims made. Policies such as general liability or commercial auto are occurrence based. This means the policy in force the day the claim occurred is the one that would respond in a loss scenario. Professional policies, such as your Errors and Omissions or Directors & Officers policies, are claims made policies. This means the policy in force when the claim was made is the one that responds to the loss as long as there was coverage in place (often referred to as a retro date) prior to the loss. The intent here is not to do a deep dive into this but to know there is a difference because the next section only applies to claims made policies.
ERP (Tail Coverage) and Runoff?
Since claims made policies respond when a claim is made and not when the loss occurred, ERPs, Extended Reporting Period, (often referred to as ‘tail coverage’ or discovery period) and runoff are designed to help. In general, these are opportunities for a company to purchase time to report claims that may have already occurred (but have not been discovered yet) on a claims made policy.
ERP
In an acquisition situation, the policy is typically cancelled on the acquisition date. If your company has the option to purchase an ERP, this period is designed to allow claims that have occurred between the retroactive date on your policy and the policy being cancelled (assuming contiguous coverage) to be reported. Since this period is at the end of the policy, it is called “tail” coverage. It is important to note: any claims that occur after the policy is cancelled (even if an ERP has been purchased) would not be covered.
Runoff
Is very similar but takes place when the claims made policy stays in force after the acquisition date. In this scenario the policy is not cancelled but stays in place as ‘Runoff.’ This acts like ERP giving you till the end of the policy period to report a claim that occurred prior to the acquisition date. At that point, an ERP can also be purchased.
A common theme in both ERP and Runoff is any claim taking place after the acquisition will not be covered.
Will Your Carrier Offer ERP?
Not all carriers are created equal. Some carriers have clearly defined options (terms and pricing) for tail coverage and some only offer a free… ‘mini-tail’ [pinky finger in the corner of my mouth] of 90 days. The caution here is to be aware that not all policies will offer tail coverage. There are situations such as a hostile takeover where the carrier will want to steer clear. To protect themselves from a certain loss, they may not offer an ERP. This does not mean you will be left high and dry because there is a secondary market for this. It will just cost you…
Timelines and Cost
If a carrier does offer ERP, it will usually be defined by years and percentages of current premium. For example, a 1-year D&O Extended reporting period could be 100% of the annual policy premium while a 1-year E&O ERP could be 75%. Sometimes, these can be reduced if multiple years are purchased. This can also be negotiated with the carrier if it is a super clean account.
Here is an example from a standard lines E&O carrier for ERP on a clean account:
- 1 year 75%
- 2 years 125%
- 3 years 150%
- 4 years 175%
- 5 years 200%
Who Pays and Why?
Like all insurance answers: it depends. Typically, the company being acquired would have more of a vested interest in making sure the appropriate tail coverage is purchased after the acquisition and would pay. A good example is with a D&O policy. Since the execs of the company being acquired can be personally named on a lawsuit, they would certainly want to make sure a D&O ERP is purchased if not required by the deal. For E&O the acquiring company may want to make sure a policy such as E&O is purchased to make sure any claims that happened prior to the acquisition are covered in the ERP.
This can be paid for as part of the provisions in the sale, by reducing the amount of stock purchased, or can simply be on your own dime. Either way, it is all negotiable and should be part of the conversation before the deal is done.
Good Business Decisions
As an entrepreneur you are familiar with making business decisions on risk reward. Regardless of the outcome for your company, good or bad, there will be insurance implications. Be sure to get with your agent, broker and legal counsel to help you work through what you need to properly insure your company during and after the transition. Now let’s toast to the 39% and the folks who are still grinding to get there.
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