Why Startups Need Insurance and What Types to Buy
From New City, NY, we work with a lot of Tech Startups and Early Stage technology companies and we’re often asked – “why does my startup really need insurance? We’re really small.” Or “What kind of insurance does my start up need?” So, I wanted to write this brief guide focusing mostly on the why the average tech (internet based) startup may need insurance coverage. The bottom line is that we realize that as a startup you’re focused on getting your product or service offering up and running, and spending money on insurance may not seem sexy or necessary. Paying for talent, getting noticed, and developing your technology is on your mind and your budget – but here are some compelling reasons and thoughts on the types of insurance you need and why you need them. The basic fact of insurance is that you spend a little so that you don’t have to risk a lot. An uninsured claim in any area can be a significant hit to your cash flow and cash reserves. Why put your company, your investors and employees at jeopardy when you can offset that risk for a small investment in insurance?
If you have employees you need workers compensation by law (at least in most every state in the U.S.). Now a lot of startups classify their workers as “independent contractors” to avoid having to deal with the hassle of taxes and worker comp, and in the near future Obamacare, but several regulatory authorities have something to say about that practice. The IRS has a litmus test of sorts which will differentiate a true independent contractor from an employee, which can be found here.
State tax authorities follow a similar test, as do most workers compensation boards or regulators. In New York there is a concerted effort between the tax authority and the workers compensation board to find companies that may be intentionally mis-classifying workers in an effort to avoid taxes and insurance.
The point is, talk to us, talk to your tax professional, talk to your outsourced CFO for advice on this and don’t risk it. If your workers should be classified as employees or they already are, and you don’t have workers comp insurance, the fines are pretty steep, especially in New York. Every 10 days of non-compliance will cost you $2,000 plus other penalties. That means if you go without workers compensation for 3 months your potential fine could be $18,000! Conversely the premium for a small tech firm may be as low as $1,500 for the year!
Here we are going to group together general liability, professional liability – often called Errors & Omissions or E&O insurance, media liability, cyber liability, etc. into one bucket because they are often sold in conjunction with each other or are packaged into one policy form. In any event the reason you need liability insurance is because as the aged old expression goes – stuff happens. And when “stuff” involves bodily injury, or property damage, or financial harm to a third party it’s usually going to be costly. If you’re developing an app, a website, a widget, or some other functioning piece of code or functionality that can be used by hundreds or thousands of users there is always the potential something can go wrong and trigger unintended consequences. If that happens, the injured or harmed party is going to come to you looking for remediation of their loss.
Here are few examples:
General Liability/Medical Payments: You have your power cord running from your laptop to the electrical socket near your desk in your share office space. A worker or guest from another company trips and falls on the cord suffering minor injuries and a broken tooth. They come to you looking for payment of $1,800 in medical/dental bills. Not a big deal, but without insurance that’s an out of pocket non-budgeted expense.
Privacy Breach: Your website has credit card processing functionality through a third party vendor. Your site is hacked and the intruder gains access to personally identifiable information of 500 of your customers. Under federal and state law you must notify those customers and provide credit monitoring services to all of them for 2 years at a cost of $220 per record totaling $110,000. Cyber insurance will cover this exposure which otherwise would be an uncovered loss. Think it doesn’t happen? Just Google “companies being digitally hacked in 2013” – I think you’ll be shocked at who makes the list and how often data is breached.
Denial of Service: The functionality of your website / your digital asset / your application suffers a glitch and shuts down for 4 hours. Customer data is unavailable and your users suffer some form of financial damage; they sue in a class action suit for millions. You believe your TOS agreement is your primary shield from damages like this, but in order to extricate yourself from the suit, your company faces legal fees for defense that run into the tens of thousands of dollars. Imagine that your TOS does not hold up in court and you face a judgment running into the millions on top of the legal fees.
Theft of Client Data / Loss of Corporate Digital Assets: An employee with your company laptop leaves their computer on a table in Starbucks to go use the restroom; when he or she comes back to their seat the computer is gone. The $2,500 MacBook isn’t a big deal, but the sensitive client data on it is. The thief now has thousands of customer and employee records all containing valuable and personal information in his hands and you are forced to report it to the authorities. Like the example of the hacking incident above, you are subject to notification laws and the costs associated with this release of private information. But here’s a twist on this example: What if that client data on the laptop also included sensitive information which was protected under an NDA because it so valuable – like patent information? Or code, or formulas, or any number of things that your client would be horrified to learn was just now out in the public realm. Your company could be facing a significant lawsuit from that client(s) for loss of digital assets. What do you do? What would this cost you? What if the data on that laptop wasn’t client data – but your data. It was your code, or site architecture, or “secret sauce”. What sort of financial harm do you think you could suffer if that fell into the hands of a competitor?
Personal Injury / Product Disparagement: One of your employees disparages the product of your main competitor over social media. Because that competitor monitors their name on the web they see it and file suit for defamation, disparagement, and advertising injury. The suit is for $2,000,000 and while there is little chance they will ever see that in a court settlement it’s going to cost at least $100,000 in legal fees to litigate it and possibly settle out of court for something significantly less.
In short, when your product fails, or there’s a glitch; when someone suffers financial harm, bodily injury; data is stolen or lost; or feels you have defamed them; as these examples illustrate, there is the potential for legal actions. Liability insurance which is structured broadly enough to address the issues of technology firms will respond to defend you in a lawsuit and pay for the ultimate settlement.
The risk that something can happen is always present but the severity of that risk is scary. Just because your firm is small doesn’t mean that you’re immune to a potentially large lawsuit. And the cost of a broad liability package for a tech start up could be in the range of $3,500 to $5,000 a year, so it only makes sense to protect your investment, your hard work and the investments of others from potential liability by purchasing insurance.
STATUTORY DBL OR DISABILITY – (NEW YORK)
In New York there is a small coverage known as Statutory Disability or commonly DBL – this covers a portion of wages lost by employees who suffer from an off-the-job injury. Yes, off the job. It’s a statutory or mandatory coverage in NY. In NJ it’s part of the payroll tax structure so a separate policy isn’t necessary. For a few hundred bucks a year you’re covered. We recommend enhancing the policy to provide two or more times the statutory benefits since the premiums are very low and underwriting is easy. When competing for talented workers this is a low cost/high impact benefit that makes sense.
Your hoteling arrangement, incubator, or shared space may be providing you with desks and basic office furniture so you may not need a lot of property coverage. Even if you have your own office the limit of property coverage may be minimal, just make sure you have enough coverage to protect computers both on and off the premises. Property insurance when incorporated into a liability / business package may run a few hundred dollars a year and is well worth the expense.
Many package policies (often called BOP or Business Owners Policies) will include a sub-limit for employee dishonesty and other “crime coverages”. We recommend looking at those limits for sufficiency. Typically there will be $10,000 to $25,000 of employee dishonesty coverage automatically included, but that may be insufficient due to the size of your budget and cash flow. Increasing the limits and adding in protection for Computer Fraud and Fraudulent Funds Transfers may be necessary if your firm has large cash balances at any time or consistently during the year. Large is anything more than $50,000.
That’s about it for the Property & Casualty coverages for a start up. As you can see the starting ballpark premium will be around $6,000 for the year depending on the type of business you’re in, but with a short conversation we can help figure out what your premiums should be based on your specific situation. It’s a reasonable investment for the protection it provides and keeps you out of trouble too! Please don’t hesitate to contact us in New City, New York with any questions you may have on insurance for your technology startup.