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How startup founders can protect themselves from getting sued

Updated: Sep 11, 2020

Talking with a founder friend recently I heard: “I totally did not expect this. I thought that only people in the US get sued left, right and centre, and now I’m stuck with this painful headache that’s costing me a bomb!”

Ouch! It is true that there is a common misconception that when you run a private limited company, your personal assets are shielded. Unfortunately, while shareholder liability is capped at the value of their shares, this is not true for anyone who is making decisions for the company, including founders, directors and even managers.

Just when you thought that this was bad … it gets worse. According to the Company Act, your startup is a separate legal person and cannot pay for your legal fees if you are the one being named in a lawsuit. So why would someone go after you as a founder or director, rather than suing a startup?

The answer is simple. Now that there are more cases, there is higher awareness with more lawyers who specialise in this so lawsuits are quickly increasing. In some cases, it’s all about inflicting the pain while in others it’s easier to extract money from the founder or investor rather than the company.

The other unexpected finding is that the biggest expense turns out to be the cost of lawyers rather than the amount of final settlement. The usual 80/20 rule applies and out of a typical US$200,000 cost, based on feedback from lawyers and insurers, US$160,000 goes to the cost of legal defence.

There is, of course, a wide range of costs, starting from US$20,000 for a quick out-of-court settlement and ramping all the way up to US$1 million for protracted multi-year litigation. Most founders don’t have the luxury of a sufficient cash buffer and the real cost of ignoring this is having to scramble to borrow this money in case you get personally named in a lawsuit related to your startup.

The smart solution which an increasing share of startups choose is management liability insurance, commonly referred to as D&O or directors and officers. This is an absolute essential insurance for startup founders that covers a wide array of messy lawsuits.

It de-risks running the business and pays for both the cost of the lawsuit against management, directors and founders. Management liability covers the cost of defence and legal expenses, the cost and expenses for official investigation and enquiries, and crisis containment for claims made against management for negligence, error or omission in their role of managing the company.

The key things that this policy is not meant to cover are actual cheating, criminal activity or fraud and founders suing each other.

Typically the protection that most startups choose is US$1 million which is sufficiently large to cover most lawsuit scenarios and in most cases costs less than US$2,000 annually.

This insurance is an absolute no-brainer as it protects personal assets and is paid by the company. As such, it is also a requirement for most VC investments, as it is placed as part of the closing conditions for investment rounds.

Working with many of the leading startups and investors in Asia, we’ve seen a variety of ill-fitted management liability insurance policies, due to the lack of transparency and it being bought as a check-box exercise. More surprisingly yet, a number of insurance coverages had actually lapsed.

Back to my friend, he ended up, unfortunately, having to borrow money to settle the lawsuit headache.

At Anapi, we are on a mission to help founders save this avoidable headache so that you can focus on building awesome businesses that transform the world around us. We collaborated with a speciality insurer with deep experience in management liability to tailor insurance to specifically protect startups.

This makes it a lot easier to activate in case you do get hit with a lawsuit and it is a lot simpler and faster to buy, with a typical turnaround within 24 hours rather than the typical three to four weeks.

Anapi is a Singapore registered insurtech company who is working in partnership with a number of leading insurers. The company is authorised to arrange insurance in Singapore. The article is provided for general information purposes and is not meant to be taken as legal advice, recommendation to buy insurance or financial advice.

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