VCs understand that risks are part of investments into startups. But what about their own risks?
VCs are well versed in what risks to look out for in potential investments. They are always balancing the risk-reward seesaw for the end goal of an exit. VCs themselves are faced with investment and operational decisions, all of which hold an element of risk. But what exactly are the risks to VCs and what sort of insurance policies are out there to protect them?
The main risk to VCs is legal in nature. This can be detrimental to the balance sheet as legal defence costs can easily rack up. Some insurers offer Fund Manager insurance policies which are applicable to VCs and typically encompasses three types of coverages: Directors & Officers (D&O), Professional Indemnity (PI) and Crime.
This protects the personal assets of the directors of the VC from claims of company mismanagement. This can come in the form of lawsuits or formal investigations.
VCs are regulated entities due to the nature of business of financing and fund management. Being regulated opens them to the risk of being investigated. In Singapore, that means being investigated by MAS. As soon as a formal enquiry or investigation is underway, the VC needs to engage in legal advice. Of course, not all investigations will result in charged cases such as this recent example of a fund manager in Singapore for cheating and fraud. However undergoing the process can be quite the costly exercise which is a direct hit on the director’s personal assets. D&O insurance provides cover for the legal defence, settlement costs and potential fines.
This protects the firm from lawsuits arising out of errors or negligence in the professional service provided.
As a fund manager, VCs need to manage the expectations of their investors about their investment performance. VCs could be sued by investors because of errors in managing their portfolio. The intention of the PI coverage is to cover the legal defence costs for the VC in case of these lawsuits.
Why the need for both D&O and PI covers?
Claims sometimes fall into grey areas. The insurer may argue that a claim has occurred because of a failure in management’s responsibilities (D&O) instead of a failure in delivering the professional service (PI), or vice versa. It is much safer to have the D&O and PI coverages with the same insurer so that you are not in the middle of a dispute between two insurers who think the other insurer should be paying the claim.
Some VC Fund Manager insurance policies include Crime cover. This is intended to cover fraud and dishonesty losses suffered as a result from employees and other third parties. Whilst crime risks may not appear to be a particularly high risk for VCs, it is a useful cover to have as it extends to cover documentary and electronic fraud and even extortion.
Many VCs not only just invest in their portfolio companies through funding, but they also play an active role in the companies by taking a board seat and providing mentorship to the founders. This can be seen as a way to ensure influence for profitability of the investment portfolio companies. Being on the board also allows them to drive company decision making for growth. The same potential legal risks arise for the VCs when they are board members of their portfolio companies. The risk of being sued or investigated apply in these cases. A D&O policy taken out by the portfolio companies protects the entities and all the directors in such cases. When you are actively pushing your portfolio companies to succeed and disrupt, a D&O policy can be the security blanket to protect your personal assets as a director.
Anapi not only provides solutions for startups and SMEs, we are also helping VCs get the protection they and their portfolio companies need.
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