The directors and officers of cannabis startups make some risky decisions. This is cannabis we are talkin’ about! Directors & officers insurance (D&O) allows them to do so more freely. This policy safeguards a company’s individual directors and officers from claims based on their decisions made while acting in a corporate capacity.
And while coverage varies from policy to policy, D&O generally provides coverage for board members and executives (as well as their personal assets). D&O may additionally offer protection for the cannabis company itself (as well as a specified member of the board) by reimbursing the company after indemnifying a director/officer.
The mechanics of a cannabis D&O lawsuit
Suppose you’re a CEO of a cannabis company. You have a red hot startup but the investors claim you misused the funds they’ve put down and want their return on investment pronto. They may even sue you personally.
“But my company’s bylaws will protect me” you counter. Maybe. But maybe not. This is where cannabis D&O insurance steps in.
Understanding cannabis D&O insurance coverage
D&O is a distinctly unique type of insurance. Whether we’re talking about a cannabis company or a bank, all policies contains three main agreements, called Sides A, B and C, respectively.
Side A provides coverage for losses of an insured person (director or officer) in the case a cannabis company can’t indemnify him or her. This may happen because the company is prohibited by law (or refuses to do so). But more commonly, the cannabis company cannot indemnify that director or officer because of insolvency.*
Side B provides coverage for the cannabis company for its indemnification obligation to its directors and officers.
Side C is known as entity coverage. It ensures corporate coverage whenever the corporation is sued along with the director or officer.
*Side B and C are both subject to a retention while Side A is usually not.
Cannabis startup D&O insurance – real life examples
By nature, cannabis startups are more agile and less risk-averse than other companies. Decision-makers (directors and officers) often make decisions at breakneck speed and may not have the time to evaluate all of the potential risks. Especially on the plant touching-side with compliance, the regulations are complicated and ever changing. That’s why the potential for a D&O claim is higher for startups.
Example 1: Let’s say you’re eager to secure funding to get your cannabis business up and running. In many (if not most) cases, investors will require you have D&O insurance put in place, especially if they are putting someone on the board. Why? Because D&O insurance ensures that the assets of these individuals are protected against claims while they are acting as a director or officer.
Example 2: What if an investor alleges you’ve made fraudulent claims in your investor deck? A D&O policy would offer coverage for the defense costs associated with this claim. Until final adjudication deems the allegations true or false, insurance will cover the costs.
Example 3: You have a “budding” new company that has raised capital. Failure is not an option…until it happens. If something were to go down and you couldn’t achieve the stated return on investment in a timely manner, you may be exposed to an action to reclaim whatever investors can from their investment.
Again, a D&O policy would protect the directors’ and officers’ personal assets, (as well as the cannabis company itself) from such claims.
Example 4: D&O insurance can be a helpful recruiting tool to bring industry leaders to your side. If successful and knowledgeable people know they can make decisions on behalf of your cannabis business without facing a personal lawsuit, they’re more likely to join the team, right?
Okay, so what can I expect to pay for a D&O policy?
Expect a broad range of costs. Cannabis D&O insurance policies can range from $3,000 to $10,000 in premiums for every $1M in coverage. So a $2M policy may range from $6k to $15k.
And that’s only a rough estimate. Plant touching businesses and investment funds are often much higher. The pricing and premium is based on several factors:
- Class of business. Certain industries have higher risks for D&O claims (fintech, healthcare and venture capital firms, for instance). Cannabis is one of these industries.
- Investor base. Who’s on your cap table? Do you have outside investors or are you mostly self-funded?
- Capital raised to date. The more capital raised, the greater the risk. The higher the limit, the higher the premium.
- Financial performance. Cannabis companies that foretell success over the long run will be more favorably underwritten than who are struggling. D&O underwriters want to know that the projected breakeven will occur during the second year and expect profits to grow thereafter.
Now that you know how a D&O policy operates, why you need it and the approximate cost, here are some other points to keep in mind:
- If you’re just starting out in the cannabis industry, an insurance company likes to see your pitch deck/investor deck. This provides them with a clear idea of the nature of your company as well as your roadmap.
- Financials. Underwriters are most interested in audited financials. But if those aren’t available, they will often work with unaudited statements and even pro forma statements when necessary.
How do I get startup D&O insurance for my cannabis company?