Corporate venturing (CVC) membership of US trade body the National Venture Capital Association (NVCA) increased by 18 last year alone, resulting in the highest number of such members since the sub-group was created in 2004.
Many CVCs are also now raising capital from outside lim-ited partners (institutional investors), as well taking a more active and direct advisory role with their respective portfolio companies.
Together, these factors not only increase the profile of CVCs but also their risk of legal liabilit.Traditional insurance options, such as venture capital policies (VCaps), translate directly to a general CVC risk.
We are finding, however, that many CVCs rely on their parent’s directors and officers cover (D&O). This approach is not necessarily wrong, provided the decision is based on a full and accurate understanding of the pros and cons of this approach.
The main benefit is cost – typically zero or relatively low. The main negative is that it leaves substantial gaps in protection due simply to the fact that those policies are designed to serve the needs of a sector that is very different from an independent venture capital firm.
Outside directorship liability
VCap claims activity has increased 20% to 30% in the past two years, driven largely by increases in claims related to mergers and acquisitions and employment.
Yet the most significat risk, from both a frequency and severity perspective, continues to be portfolio company outside directorship liability (ODL). Whereas VCap policies automatically cover all current and future ODL risks, corporate D&O policies limit automatic coverage to service with non-profit entities.
For-profit exposures must be scheduled to the policy. This not only increases costs but places the administrative burden squarely on the CVC to make sure the full ODL exposure is covered, an affirmative obligation that remains as new investments are made.
The situation becomes more complicated if the parent is a private entity and the portfolio company is public, as virtually every pri-vate D&O policy excludes public exposures.
Services-based liability
CVCs also face potential liability arising from the professional services they provide, both in connection with managing funds as well as services to portfolio companies. Corporate D&O policies are not designed to address this risk and go further by typically excluding professional services.
The exclusionary wording will vary and most include a carve back for certain D&O-type claims, but a significantgap in coverage remains.
Scope of coverage
Generally, the coverage provided under a VCap policy will be broader than a corporate D&O policy, with the obvious caveat that any comparative analysis is complicated and nuanced.
This is particularly true with respect to key definitions, such as claim and loss, and also with deductibles, which may be significantly lower if the parent is a large corporate entity. Further, CVCs with public corporate parents should understand the limitations built into a public D&O policy with respect to direct claims against the company, and how this may affect claims against the CVC at both the fund and management entity level.
The non-profit parent
In this case, there is the added complication of taking an insurance product designed for non-profitrisks and trying to adapt it to address for-profit exposures.
Theoretically, it can be done. We simply advise added caution when relying on a product or underwriting group whose mission, claims experience and contract intention may be funda-mentally different from the risk a CVC is trying to address.
Risk management and best practices
Regardless of the product selected, insurance should be viewed as one element of a larger risk management approach, particularly towards the largest risk – ODL. It should be complementary to additional best-practice measures implemented at the portfolio company level, such as adequate and quality D&O or broad indemnification agreements that define the scope of the obligation, as well as the primary responder.
The stronger the protections at the portfolio company level, the more flexibility a CVC may have when structuring its own insurance needs.
Finally, although this article has focused on VCap as the main alternative, it is not the only one. While VCap is the most comprehensive, it may not be appropriate for you. One size does not fit all.
A number of creative solutions are available to address specific risks, depending ultimately on your individual risk philosophy and situation. The key is having enough information to be comfortable that you are making an educated decision.
First published in the NVCA’s monthly newsletter, NVCAToday