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Going public is one of the most common goals that just about every startup founder strives to achieve. An initial public offering (IPO) represents the first time that a company sells stock to the general public, moving the company out of the private sector so that its shares are no longer only available to a handful of prominent shareholders; usually founders, top executives, and investors.
After the IPO, anyone from the general public that is interested in buying stock in your company can do so.
2019 was a huge year for IPOs, with a significant number of hugely successful unicorn startups going public, including Lyft, Uber, Pinterest, Slack, Zoom, AirBNB, and many more. And while many experts claim that initiatives such as the Jumpstart Our Business Startups Act (JOBS Act) are making it easier for companies to go public by loosening some regulatory issues and lowering the barrier for entry, going public is still a difficult and complex process.
Not only is the actual pre-IPO preparation process incredibly complex, growing your startup to the point where you can make such a decision takes a lot of work. As a startup founder, some things to ask yourself about the current state of your company include:
- How are my company’s financial performance forecasts?
- Is the leadership team experienced enough to take the business to the next level?
- Am I confident in my board of directors’ ability to provide the right direction for the company?
- Is my company ready to be audited?
- Is my plan for scaling stable and achievable?
- Am I willing to give up company control in terms of direction?
- Do we have a sustainable growth strategy in place?
- Are there any risks or liabilities that might uncover themselves in the process of listing?
Weighing the Pros and Cons of Going Public
Most companies that make the decision to go public do so because they believe that it’s the best way to take their business to the next level. At times, the vision that a founder has for his or her startup cannot be reached with the resources that the company has to work with as a private entity. Therefore, by accessing new levels of capital, a founder can achieve his/her vision while providing liquidation for employees and investors.
Regardless of what your future goals are, it’s incredibly important to first take a look at both the potential pros and cons of an IPO in order to see if it’s really what’s best for your company at this point in time.
Raising capital is easier: An IPO can typically raise upwards of $100 million and when your company has raised significant money by selling stock, further financing options are much more plentiful than they are when you are getting all of your funding from traditional investors and venture capital firms. And if you want to attract new investors, going through all of the IPO-related regulatory compliance processes shows potential investors that your business is sound and a good place for them to invest.
Borrowing money is easier: It’s both easier and less expensive to take out loans as a public company thanks to the accounting oversight and public disclosures that an IPO requires.
A boost in reputation: Investors are not the only people who will take note of the fact that your company has gone public. Your credibility will also improve in the eyes of customers, vendors, partners, and just about anyone else you are looking to attract. Going public will also boost your company’s visibility considerably.
Shares are worth much more: Private companies have shares that they distribute between founders, executives, investors, and employees that are most valuable upon a liquidation event such as the company being sold or an IPO. Share prices trade at much higher values once they reach public markets.
Recruiting top talent becomes easier: Now that your company’s stock is actually worth a significant amount of money, offering employees equity is a great way to attract top-tier employees and management.
Poor performance: Not every company that goes public succeeds and no one can guarantee that your stock will perform well after the IPO, no matter how diligent you have been throughout the process. If the stock price falls below your IPO price, your company could be in serious trouble.
Burdensome public reporting: A public company immediately enters the spotlight and must report regularly and in detail on its operations and finances, which could put a lot of stress on leaders. This is especially true if your company is not performing up to expectations.
Increased costs of operation: Being a public company is a lot more expensive than staying in the private sector. There’s IPO roadshows, compliance, and continual spending of more money every year on just about every aspect of your operation, including but not limited to your legal and financial reporting responsibilities.
The threat of activist investors: An activist investor is someone who will buy shares in a company that they believe is not performing very well. This investor will then try to pressure management into making changes in the company such as shutting down underperforming sectors, swapping out management, and even trying to get you to sell the company. Obviously, this sort of thing can be a huge distraction for everyone involved.
Transferring Risk: Defining Your Insurance Strategy
Before any startup begins the process of preparing for an IPO, a complete reassessment of the company’s risk management and risk responsibilities needs to be performed. New and old stakeholders, including but not limited to auditors, regulators, analysts, investors, and directors, will have a great impact on the company’s risks and ability to stay compliant over the course of the coming pre-IPO period and into the future as a public company.
Assessing your startup’s risk before going public is an ongoing process and should include:
- Being aware of all regulatory changes that can affect your business.
- Setting and managing the expectations of all shareholders.
- Making sure that your financial projections and goals are realistic.
These are some of the main pillars that your risk management plan should be built around as they are some of the determining factors related to the many new and complex risks that your startup will face once it goes public.
Understanding Post-IPO Liability and Exposures
One of the most obvious differences between private and public companies is that public companies are under a much greater level of scrutiny, especially in terms of government regulations and compliances.
There are a vast number of securities laws that were created in order to act as a support system for corporate governance and build public trust. Making sure that you are not in violation of these laws is a fairly painstaking process, which is why you basically need to assume that your company will face a significantly larger number of claims after it’s IPO no matter what.
Your startup’s journey navigating a vast sea of liability and exposures starts even before the IPO. Most experts point to the startup’s roadshow as the real start of these concerns and the arrival of new risks and exposures that your company might not have been exposed to within the private sector.
For those unfamiliar with the term, a roadshow is basically a promotional tour for your company that’s put together in order to announce your plans to go public. What usually happens is that members of the investment firm that will be underwriting and issuing the IPO will plan a tour across most of the main markets (New York City, San Francisco, Los Angeles, Chicago, etc.) in an effort to create excitement and drum up interest and support for your company. The success of your roadshow could make or break your IPO.
The business, financial, and legal decisions your company makes in preparation for the roadshow and especially the statements and promises that are made publicly during the roadshow can lead to serious claims if not handled properly and made good on.
Essentially, the main sources of liability for post-IPO startups are the federal and state securities laws with liability arising from failing to meet financial projections, failing to deliver on products or services according to timetables that were promised, accounting restatements, whistleblower complaints that might lead to internal investigations, and a long list of possible investigations by regulatory bodies such as the Securities and Exchange Commission or Department of Justice, among others.
The Importance of Directors & Officers Insurance
A majority of the new risks that come into play post-IPO affect and target the leaders of your organization. Your directors and officers might be used to stress, but everything they have experienced until now will be amplified once the company goes public, which is why protecting them is an absolute priority.
Having the right D&O coverage is vital because the decisions your leadership makes affect everyone; other board members, employees, clients, vendors, and shareholders, and a singular mistake or poor decision made by one director or officer can have serious ramifications for them all.
If you’ve gotten to the point at which you are considering becoming a publicly-traded company, then you have certainly already purchased directors & officers insurance, which is a critical IPO insurance coverage for any serious startup insurance program. Having D&O insurance as a growing startup makes you more attractive to investors and executives, helping you raise money and find the right leaders who are going to enable you to go public one day.
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D&O insurance protects your leadership and their private assets from the many risks that they face in the day-to-day operation and management of your company. The level of scrutiny they will face as leaders of a public company will only increase, which makes it more important than ever to mitigate the many risks they face with insurance so that they can focus on successfully running the business.
D&O coverage will pay all legal costs needed to defend against any claims made against your directors and officers, as well as any settlements and awards that may arise from litigation and financial costs related to reputational damage. Whether or not your directors and officers are ever found guilty of any of the claims is irrelevant; financially covering the usually long and expensive court proceedings is what D&O policies were created to do.
D&O policies that are purchased by companies post-IPO will usually provide protection for a longer list of stakeholders that extends beyond just the directors and officers. A good policy will also protect some of the more important financial obligations of the company, and this dual protection model can often lead to diverging interests in terms of what’s best for the directors and officers and what’s best for the company, which is why the process of putting together a strong D&O program becomes much tougher when an IPO is involved.
Typical Timeline Ahead of IPO
While there are no rules on what your process should look like exactly leading up to your IPO, the general rule of thumb is that your D&O policy should become effective on the date your registration statement covering the traded securities (Form S-1) takes effect.
Typically, you’ll want to start defining your D&O strategy before filing the Form S-1, meeting with brokers and your internal and external legal teams to go through what your policy should look like, which carriers you’d prefer to go through, how much you’re willing to spend on the policy, what limits should look like, and more.
Once you have a good idea of your needs and strategy, you will file the Form S-1 and then meet with the underwriters so that management has an opportunity to clearly present the company’s financials and operations in order to get a better feel for potential issues that could arise related to corporate governance. To put the timeline in perspective, these meetings will usually be held during the roadshow period leading up to your IPO.
Further discussions and analysis should take place between management and various advisors to get all of the details of the D&O right, including limits, retentions, and other coverage specifics. This final stage of analysis can take place once your quotes have been submitted to insurers. Finally, you can bind the insurance ahead of your Form S-1 taking effect, knowing that your leadership will be well protected once your stock goes public.
Typical Differences Between Private and Public D&O Insurance
No matter whether you are a private or public company, you are purchasing D&O insurance to cover the same types of situations, for the most part. One of the biggest differences when going public is that you are going to have to pay significantly more for D&O insurance since you’re all but guaranteed to be seeing an increase in the frequency of claims after your IPO.
The other main difference is that D&O coverage is generally written to provide broader coverage post-IPO. Since the risk of securities claims is so much greater for public companies, Side C coverage will specifically cover those risks. In comparison, Side C coverage for private companies will cover all claims, including regulatory ones, antitrust claims, ones that are employment-related, and more, unless specifically excluded.
How D&O Policies Are Written
Leading into an IPO, the process of putting together a good D&O policy should be a dynamic and ongoing one. It’s important to work with your brokers in order to build a D&O insurance program that addresses and covers critical risks before, during, and after the offering.
Founders and other stakeholders must realize that trade-offs and compromises are going to be needed and that it’s important to find a balance between what’s best for the company as a whole and what’s best for its directors and officers.
An example of this is when a company buys coverage against non-indemnifiable claims for both the company and its leadership with a shared limit of liability. If a large claim arises, there might not be enough money available to protect everyone, which might require you to purchase additional limits or dedicated coverage for your directors and officers.
There is no right or wrong way to purchase D&O coverage, which is why detailed analysis and risk assessments, along with peer benchmarking and industry research, are all important parts of the process of finding the coverage that best first your company’s needs. Most D&O policies leading into an IPO will need to include all three of the basic insuring agreements commonly associated with D&O coverage:
- SIDE A: Protecting the personal assets of your directors and officers by covering the losses of your leaders that result from claims for which the company has not indemnified them.
- SIDE B: Protecting the company against losses resulting from the company indemnifying an officer or director for claims that were made against them.
- SIDE C: Protecting the company against losses resulting from securities claims made directly against the company.
Efforts being made towards keeping your company and leadership protected should not end after purchasing your D&O policy. It’s important to stay in contact with your brokers and lawyers to continue assessing your risks as time goes by and your company (hopefully) continues to grow and prosper.
It’s recommended to enroll your leadership in training and education programs in terms of practices associated with navigating newfound risks and liabilities as the directors and officers of a public company.
For the most part, D&O insurance is the only coverage that is really going to need considerable reassessment and significant changes compared to the policy you procured as a private company. However, there are several other typical IPO insurance policies that you should reassess as well to see if changes need to be made in light of your IPO and ensuing changes within your company.
Employment Practices Liability Insurance: Covers claims against your company related to harassment, discrimination, wrongful termination, and more. Naturally, public companies tend to become a greater target for these types of claims compared to private ones.
Fiduciary Liability: Covers against errors and allegations of mismanagement related to administering and managing employee benefit plans. As your company grows and your employee benefits become more complex, you might need to reassess your coverage needs.
Cyber Liability Insurance: A public company experiences more public scrutiny, which leads to a greater number of claims. It’s no surprise then that the attention given to your company once you have gone public by hackers and cybercriminals will also intensify. Sometimes, cyber exclusions are written into D&O coverage, which is all the more reason to make sure that your cyber liability policy is covering all possible gaps.
Reps and Warranties: If you plan on selling your company or acquiring a different company, you’ll need this coverage. Reps and warranties insurance offers protection for both buyers and sellers in transactions such as mergers and acquisitions. The coverage protects against unintentional breaches made in representations and warranties during the transaction.
Specialized Investigation Policies: As already mentioned, no matter how much time and consideration you’ve put into designing your D&O coverage to make sure that it protects you from SEC investigations and FCPA actions, it might not be enough. That’s why it’s sometimes a good option to purchase specific endorsements and specialized policies that specifically cover any and all types of regulatory investigations.
- Rideshare company Lyft was sued by investors who said that the company exaggerated its market position during its IPO in March 2019, which they say led to a shedding of stock value. See: Investors Sue Lyft Over Overhyped IPO
- Cooking kit company Blue Apron was hit with class-action lawsuits, alleging that the company failed to adequately disclose material information and misrepresented its challenges with customer retention, delayed orders, and reduced ad spend. See: Blue Apron hit with multiple class action lawsuits
- Facebook’s hyped IPO turned into a huge Wall Street debacle, with lots of confusion and more than 40 lawsuits filed regarding the Facebook IPO in the month that followed. See: Facebook IPO: What the %$#! happened?
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