Successful venture capital funds (whether cannabis specific or not) frequently invest in a blended venture capital (VC) insurance policy to provide protection from three main exposures. These include management liability (also known as directors & officers or D&O), professional liability (also known as errors & omissions or E&O) and employment practices liability (EPL).
These combined policies can cover a range of situations so any cannabis fund is prepared for the mother of all expenses: legal defense costs.
Here’s a few examples that could send your cannabis company into the red if you’re not careful:
Scenario 1: An investor of your cannabis fund sues you for breaching your fiduciary duty following an investment decision. (Smith v. Van Gorkom)
Scenario 2: An employee in your company sues for gender discrimination. (Pao v. Kleiner Perkins)
Scenario 3: Your cannabis fund is sued by former management of one of your portfolio companies. (Carsanaro, et al. v. Bloodhound Tech, Inc. et al.)
Scenario 4: A portfolio company of yours goes bankrupt. The board member you put in place is named as a defendant in a lawsuit from the trust. (Just For Feet bankruptcy case)
What do all these examples have in common? Ka-ching. Costly legal defense that can severely impact your cannabis fund.
Enter VC insurance, stage right.
The Cost of a Suit
A variety of factors come into play when it comes to the cost of a lawsuit. These include: the nature of the allegations, the amount of work it takes to litigate the case, the venue of the trial, the rates charged by each law firm, and (of course) the final settlement or judgment.
Between the costs of the defense and the settlement, litigation could run your cannabis startup anywhere from a couple thousand dollars to hundreds of thousands of dollars.
When you factor in these expenses into your IRR (internal rate of return), one substantial lawsuit could mean the difference between an automatic re-up by your LP’s or a lengthy explanation to an unhappy group of existing LP’s (and that’s if they stick around).
And we haven’t even touched upon the damage to your reputation (a separate issue that can also cost you dearly).
And while your venture capital insurance policy can’t protect your public perception, it can lessen the cost a trial would take on your resources. This frees you up so you can focus on reputation management.
Bottom line? Regardless of the end result, a lengthy trial can threaten your current operations. But it doesn’t end there. It can also impact the financial strength and performance history you’ll need to refer to during your next offering.
So when your venture capital insurance carrier pays the defense and settlement costs for a covered claim, you (and your investors) can sleep easier at night.
The Price of Protection
So how much venture capital insurance should you buy and how much will it cost you? The unsatisfying answer: it depends.
The decision is based on your cannabis fund & portfolio size, history and nature of operations, to name a few factors. (Your broker will also use industry benchmarking in making a recommendation so be assured, this will be more than just an educated guess!)
The amount you should pay versus the amount VC insurance underwriters want to charge can be two very different issues. The underwriter will examine factors such as your total assets under management, the nature of your investments, your claims history, the composition of your limited partners–even the CPA that conducts your annual audits.
Your broker will also gather quotes from several underwriters, negotiate with them and present you with the best options for your unique needs.
As a baseline, use $12,000 – $15,000 for every million dollars. But that’s just a baseline. This rate depends on the total amount you plan to purchase, the state of the insurance market, the insurance company and the unique risk profile presented by your cannabis business. The only real way to really know the cost: get in touch with an expert who can see how the market values the risk.
In a nutshell
Venture capital insurance is a viable and versatile risk management tool for cannabis fund of any size. It allows you to focus on the reasons you got into the cannabis business, instead of worrying about the financial impact of events often out of your control.