Tech startups are enjoying a strong run of venture capital funding, coming off a surprisingly strong 2020 for investments and well into what appears to be an even hotter 2021.
This sharp uptick in VC funding for tech startups means there are a host of emerging tech companies that are thinking about how to scale their growth and make the best investments with that influx of cash.
In the fever of new funding entering a hard-charging market, startup founders are in offense mode, moving fast to take advantage of growth opportunities. But if founders move too fast and don’t think defensively, all of their hard work and early successes could be jeopardized.
Insurance is one element of a strong defensive strategy that is often overlooked but holds significant implications for startups. Navigating the purchase of business insurance is seen mainly as a necessary evil, but for tech startups that are eager to move fast and bring their product to market, viewing the purchase merely as a checkbox item often leaves them vulnerable to risk. Many standard policies don’t cover unique situations to the tech industry — and therefore don’t give startups the right protection.
In my role as the CEO of Embroker — whose mission is to make it radically simple for companies to get the right insurance at the best price — I work with tech startups every day. And I’ve seen how failing to accurately identify and assess risk can leave even the most promising startups with costly exposure.
But there is good news: Founders who take the time to better understand how different policies do or do not cover startups’ biggest risks are better equipped to secure coverage that mitigates those risks, leaving them free to focus on product development and go-to-market strategies.
I’ve identified the most common insurance pitfalls I’ve seen tech companies encounter — as well as the simple considerations that will help them guard against those risks.
Startups and SMBs: Their Similarity Is in Their Uniqueness
While small businesses and tech startups share many similarities (and even many of the same growth challenges) there are distinct and critical differences that mean a tech startup’s exposure is very different from that of your average small business.
Think of it this way: Most small businesses don’t think of themselves as a small business. They’re restaurants. They’re retail shops. They’re marketing agencies. Small-business owners think of their businesses like this because they have to consider their unique needs in every part of running their company.
This is no different for tech startups. If founders are simply choosing insurance aimed at a small business, they’re choosing an off-the-shelf solution that isn’t customized to the unique challenges, risks and needs of a startup in the tech sector.
Standard B2B Contracts Often Introduce Unintended Risk
Many times, founders mistakenly believe that their errors-and-omissions (E&O) insurance policy will cover any risks they’re unaware of within their contracts. Often, they make a costly mistake when purchasing these policies — opting for cheaper premiums. For many E&O policies, saving on the premium means sacrificing much of the contractual coverage that founders believe is included.
This is especially true in B2B contracts where, for instance, standard clauses like indemnification or breach of confidentiality usually aren’t covered in E&O cyber policies. Many times, a combination of policies may be needed to cover the stipulations found in contracts.
For this reason, founders must deeply review and understand both the stipulations in their contracts and the language in their policies to ensure they are aligned. Considering that in as many as 90 percent of policies, the language does not meet their needs, founders need to apply those due diligence skills they’ve gained as tech entrepreneurs to close the gap on their contractual risk.
The Hidden, Costly Exposure of Inadequate Coverage for Data Breaches
There are any number of concerns that likely keep founders up at night, but in recent years, data breaches are likely near the top of the list. As companies work to prevent increasingly sophisticated breaches, many are also missing the crucial step of ensuring they’re covered in the event the worst happens.
Even experienced tech founders often underestimate the true cost of a data breach, and for that reason, they are inadequately covered for the risk they carry. According to our research, many earlier stage tech startups opt for a $1 million limit on policies like E&O, despite the fact that most breaches easily exceed this cost. Many companies do not opt for higher limits (e.g. $5 million) until they reach later stages of funding.
When selecting coverage to cover breach risk, founders should work with a third party that can evaluate potential data breach costs, and provide a customized analysis of coverage needed.
Talent: Your Greatest Asset or Your Greatest Risk?
Hard-charging and fast-moving startups can sometimes overlook one of the most prevalent challenges in the tech landscape: that your greatest asset can also be your greatest risk as they deal with a myriad of complicated employee issues. Employee-related risk is something that every company deals with, but this is also many times an area where founders aren’t accurately assessing their exposure and securing the right coverage.
Common issues like wrongful termination, sexual discrimination or harassment, and age discrimination are often heightened risks in the tech space. Combine this challenge with the fact that founders are going for off-the-shelf solutions, under-estimating their risk and hiring quickly during rapid growth, and many tech companies are simply an employment-practices liability insurance (EPLI) exposure waiting to happen.
While EPLI coverage typically sees smaller claims, as companies grow and hire, they can expect those claims to increase in volume. Most companies are not buying enough coverage for the number of employees they have. While some startups increase limits on other policies as they increase their funding, we found that many are still holding $1 million limits on EPLI — even as they grow. This is exacerbated by the fact that tech companies are often employing higher wage earners that also require companies to carry higher limits.
And that’s to say nothing of their directors-and-officers (D&O) coverage. Our recent analysis found that tech companies are choosing premiums that are far too low, leaving them exposed to potential D&O claims that exceed their coverage. This is further complicated by the fact that venture-backed companies’ funding is a matter of public record, which can leave companies vulnerable to higher claims. In general, companies with $100 million in funding should carry $500 million in coverage.
Tech founders are typically thought of as people who understand risk — even embrace it — and make careful and calculated decisions on the path to growth and success. But many founders are miscalculating their company risks and exposure, which can prove to be a critical mistake in a landscape already fraught with challenges.
As startups surge through a strong season of funding, eliminating this common error can help them make the most of those investments.