Insights

Think of Insurance as a War Chest
POSTED 9.14.22 M&A

You know about the drama with Elon Musk and Twitter. Lawsuits are flying back and forth, with both sides alleging breach of contract after Musk declined to buy the social media giant.

For super-billionaires like Musk and multi-billion-dollar companies like Twitter, they have the millions needed for such drama. Money is no object.

But most of us don’t have that kind of cash. That means when something goes south during a liquidity event, you need to have the proper insurance coverage in place – and proper level.

But I propose that you should think about this insurance as more than just protection. Think of it as a war chest.

Here’s what I mean…

I recommend getting as much insurance coverage for every M&A deal you get involved with. Because if there is a breach or other issue with the deal, and you make a claim, you’re going to want the most money possible. You don’t want the bare minimum, which will leave potentially without enough remedy to fully cover your loss.

For example, if you’re doing a $10M deal and you’re only required to get $1M of coverage per the terms of your D&O insurance policy… you should actually get $3M to $5M in coverage. That’s your war chest.

I say this because I’ve seen many situations where companies bought the minimum, and then they were stuck with what they got.

Going back to the minimum $1M in coverage on a $10M deal… what if you need more than $1M? Say the other party wants a settlement of $1M. Trouble is that your D&O policy will only give you that much total. And you’ve already spent $500,000 in legal fees (which in California isn’t that unusual). You only have 500,000 left and that won’t be enough for the settlement. It comes out of your pocket… if more is not added on by the end.

If you’re worried about the expense, additional limits are not as costly as they once were. In a recent case with a very well-funded tech company, their initial D&O policy with $3M limit costs about $40,000. But a $5M limit is only $50,000. For just $10,000 more they’re getting nearly double the coverage.

If you are being acquired, getting higher limits is definitely in your best interest. But you have to bring it up early because if you wait, the insurer will not give you those extra limits later. Also, keep in mind that most D&O claims come during acquisitions, funding, or other signature events. All the more reason to have “full” coverage in advance of these critical times.

Another coverage line that is seeing a surge in demand for higher Limits is in the Tech E&O/Cyber Liability line. We’re seeing many on-line businesses and SaaS companies carrying minimal Policy Limits, which is understandable for controlling costs early in a company’s lifecycle. But when an acquirer comes along, they’ll insist the target secure the maximum available Limit (often $10M or greater), which either comes at tremendous expense or is not available at all leaving owners and founders to bear the risk themselves. Now Underwriters won’t provide a $10M Limit Tech/Cyber policy for a company worth $2M; however, we see tons of $30M to $50M valued companies still carrying a $1M or $2M Limit Tech/Cyber policy – which simply – won’t “do the job”.

If you’re interested in securing maximum protection for the next signature event in the life of your company, contact me, Patrick Stroth

Think of Insurance as a War Chest