How Insurance Solutions Can Help Protect Tech Companies as They Grow

Andrew Zarkowsky, Head of Technology Industry Practice, The Hartford Nick Kreczko, AVP, Hartford Stag Ventures and Dan Neubelt, Senior Analyst, Hartford Stag Ventures

From a startup with a few employees to a publicly-traded company with hundreds of employees, technology companies vary in size and can grow rapidly. With this growth trajectory, a tech company’s insurance needs will likely change because more growth can present different risks and challenges.

One factor behind a tech company’s rapid growth is venture capital funding. VCfirms raise capital to invest in startup companies with the goal of eventually selling their stakes and earning a return for investors. But not all venture capitalists play the market for the same results. These investment professionals invest in businesses for many reasons including outsized returns relative to the S&P Index, as well as portfolio diversification given some allocation to higher risk /return assets. In addition, they may look for strategic investments to gain knowledge and achieve influence over emerging technologies and gain a competitive edge in the marketplace.

Today, not even a global pandemic can slow down venture capitalists nor negatively affect their capital funding. In fact, according to Crunch base News’ “Global VC Report 2020: Funding and Exits Blow Past 2019 Despite Pandemic Headwinds,” venture funding was up to $300 billion globally in 2020– a 4% increase from 2019.

While venture capitalists invest in a variety of industries, they are particularly attracted to technology because startups in this vertical have potential for rapid scale, high margins, recurring revenue, and overall, attractive long-term growth. All of these factors can be accelerated with upfront investments.

The Venture Capital Firm Structure

Venture capital firms are typically led by General Partners or Managing Directors, who are supported by Principals and Analysts in deal sourcing and investment due diligence. In addition, there are Operating Partners who are responsible for performing fund administrative functions such as accounting, legal, and marketing. Many firms also have value-add Partners supporting the portfolio companies across a variety of functions, e.g., business development, recruiting, and capitalization. Venture capital fund investors are known as Limited Partners (“LPs”). LPs provide capital and may serve in an advisory capacity to the fund.

Venture capital firms make money in a given fund when the underlying portfolio companies exit at a profit relative to investment cost. Exits can take many forms but might include a public offering, whether through IPO, direct listing or SPAC. Companies may also exit via acquisition by a strategic buyer. And in some instances, a company might be sold to a private equity firm.

How Can Tech Companies Protect Themselves as They Grow

Technology companies grow in stages with each one bringing new, more complex risks. Insurance can help provide the security needed to keep these businesses innovating and growing as the risks they face evolve over time. From start-up to growth mode, there may be more employees or different products, which can bring challenging liability risks, so having the right insurance coverage at each stage can help prevent any costly surprises along the way.

Angel or Pre-Seed Phase

The first stage of funding for a tech company is often the angel or pre-seed phase. Founders fund their startup with their own money or with capital from friends and family. Sometimes, they may pitch their idea to angel investors to secure funding. At this stage, a tech company does not typically have liabilities, assets or contracts that would require insurance coverage. Buying insurance coverage is a proactive measure to provide peace of mind.

Seed Phase

Seed stage funding helps a company continue along its early journey. A company may be developing minimum viable products and is often testing its solution with beta customers. The team at a Seed stage tech company is often still quite small and may include the founders and a few employees, like engineers or development staff. Funding varies depending on type of tech company but can range between a few hundred thousand dollars to single digit millions.

Insurance coverage for this stage of growth can be addressed with a Business Owner’s Policy (BOP), which combines business property and business liability insurance into one business insurance policy. It is ideally suited for tech companies with unique needs because it can be custom-made to fit industry specific businesses. Workers’ compensation (WC) insurance is also important to help employees recover from a work-related injury or illness, and cyber insurance may also be essential because tech companies can be the target of cyber attacks.

Series A, B, C Funding

With Series A funding, a tech company may have established product-market fit and early revenue traction. Capital raised during this stage of growth is often used for hiring talent, typically in engineering or sales and leadership.

The Series A fundraising rounds are more formal with venture capital firms usually leading the effort. The lead investor often takes a seat on a company’s board, and other investors can join the board as members or observers, depending on the amount invested or their strategic value to the company.

Because of their size, companies often move to a more sophisticated insurance program. These typically have enhanced business liability coverages, including commercial auto insurance and umbrella coverage with a small limit. Some other insurance coverages to consider include professional liability insurance, liability insurance for large businesses, WC insurance for large businesses, business income insurance, and property insurance for large businesses.

Series B funding is similar to Series A, but often represents a larger raise. Capital is used to scale the company whether building-out sales and marketing, investing in customer acquisition and support, further professionalizing management, and directing capital to other areas of the business that need attention.

A tech company that is looking for Series B funding typically has at least one established product and possibly a product or technology roadmap. These companies also typically have early revenue growth. Investors from earlier rounds may choose to follow and invest more capital, but a new lead investor can also emerge to lead the Series B round. At this size, businesses typically have contractual, and first party needs for professional liability insurance, cyber insurance, WC insurance and commercial auto insurance.

It’s likely that businesses of this size will need to increase their coverage limits to provide more protection. For example, as a business grows, there may be more company property that requires higher coverage limits. So, increasing limits on a commercial property policy may be needed. Series B funding will also require directors and officers (D&O) insurance coverage to help protect the Board of Directors.

Startups and businesses at the Series A or Series B stage are often referred to as “early-stage” companies. Per the report “US VC Valuations Report – Q2 2021” by Pitch Book, early-stage companies received a median pre-money valuation of $41.5 million in 2021, a significant increase over 2020 numbers. The median deal size as of June 30, 2021 was $9.5 million.

Businesses at the Series C funding stage have continued to grow and mature. Funding rounds may be significantly larger, and investors may refer to these tech companies as “late-stage” or “growth-stage.” The focus is on expansion.

According to the same Pitch Book report, the median late-stage pre-money valuation is $130.0 million and a median deal size of $16 million. However, the average valuation is substantially higher – $914.0 million – pulled up my many highly valued companies worth more than $1 billion. These businesses are often referred to as “unicorns.”

Because of the size and complexity of the tech company at this stage, they need an insurance policy that’s tailored and unique to their business. Higher coverage limits are preferred to provide greater protection for the business, so businesses should review their technology professional liability insurance to make sure they have proper coverage for this stage. Policies should include software copyright, and first- and third-party cyber coverages.

Tech companies may also need multinational insurance for international locations or if employees travel abroad. This is an important coverage because most standard business insurance policies will not cover foreign claims.

Understanding the Unique Needs of Tech Companies at Every Stage

Regardless of where the tech business is in its growth cycle, insurance coverage is important. Partnering with an insurance company that truly understands the unique needs of tech companies is essential. The Hartford, for example, has worked to understand how tech companies grow and the risks they can face at every stage. The carrier has created specialized insurance solutions to help give tech companies better outcomes and opportunities for success.

Weekly Brief

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