Venture Capital and Private Equity Risk –

Venture Capital and Private Equity Risk: – Is your Human Capital Protected

What are the best solutions to protect the “human capital” exposure of their key people if he or she is disabled or dies in the first 3 to 5 years.   As these deals and transactions grow in frequency and in value, there is new pressure to solve this specific financial exposure.  But how?

Who are the potential insureds we are talking about?  It has been said that nature distributes its favors unequally. If that is the case then the brilliant minds who are business creators, CEO’s and computer programmers are case study examples of nature at work.  The art of the Venture Capital and Private Equity deal may be centered on a product or an idea, but the heart of the deal is anchored to the person or team of people who originally developed the opportunity for investment. Therefore, insurance professionals are either being asked or need to ask these clients, what is being done to insure and protect the human capital risk.

In 2011, there were approximately 3,200 venture capital transactions completed where  investors put $32.6 billion.  Of each deal, the average investment was $5 to $10 million.  These transactions created between $15 and $30 billion of invested capital into the economy.

The sudden loss of a key individual can mean

1) the loss of the entire investment

2) the dissolution of the entire company

3) the reputation of the venture or private equity company itself.

In this example, what happens to the $5,000,000 or +$10,000,000 investment of venture capital or private equity money should a keyperson become disabled?  The immediate loss of the key individual(s) from a disability can cause both short and long term loss of continuity and momentum.

Investments have risks. These risks could range from geopolitical to weather to financial market risk.  Professional investors understand the total S.W.O.T picture (Strengths, Weaknesses Opportunities and Threats). However, one risk which business schools teach but often goes ignored in the final investment analysis is the unfunded risk called Human Capital Exposure. This is the core of the issue and this is where the broker, agent or consultant brings priceless advice and solutions to these high end clients and firms.

An executive or entrepreneur “is only as good as his or her health”, yet as investors plow millions of dollars into new VC deals in the USA and abroad, this risk is not fully understood or adequately protected.  But it can be.

Disability is worse than death. Implementing the appropriate plan to protect the loss of the brilliant individual from his or her inability to work is critical to the success of the venture capital or private equity deal. It protects and stalls against an economic loss where statistics show a 45 year old has a 4:1 chance of being disabled lasting 90 days vs. death and a 2.67:1 of a disability lasting 365 days vs. death.

Here are 4 fact finding questions the insurance professional must ask each client in this category in order to sufficiently understand the human capital risk:

  1. Is your Human Capital investment fully evaluated in the due diligence process?
  2. How is your Human Capital Investment calculated?
  3. Can your investments withstand the loss of the key individual(s) from a disability within the first 1 or 2 years?
  4. Have you made contingency plans for disability or death of your critical talent?  How will this effect your investment in the short and long term?

The answers to these questions will lead to greater more detailed understanding of the overall investment risk and to whether insurance is needed to hedge against any unforeseen loss of investment.

Here is a case study example based on the answers of the fact finding questions asked above by an insurance professional:

A venture capital firm invested $5,500,000 into a biotechnology start up.  The start up company brought together the brilliant minds of 4 individuals who were experienced and respected in their fields which created immediate creditability.  The necessary financial due diligence, proforma’s and analysis were completed and the VC firm decided to make the investment.  The uncovered issue by the insurance professional showed that they had not taken into consideration in any other financial analysis, the short or long term human capital value exposure.  The true economic risk to the investment as well as the value and hope of any future IPO hinged on this team’s collective togetherness.  If any member were not able to contribute thier unique and brilliant mind during the critical start up time of 1 to 3 years, this investment could be lost due to a disability or death.

Solution:   An insurance solution for these unique individuals requires an experienced and knowledgeable market and underwriter(s) who understand the risk.  In the end, the insurance professional proposed a 3 year policy for $5,500,000 of disability coverage with a 12 month elimination period.  This policy insured the economic and contractual investment of the VC firm.  The VC firm was the owner and beneficiary and the insureds were the 4 individuals.  The policy defined disability from own occupation giving further protection to the investment of the firm.

Your tech insurance coverage professional will dig deeper by asking laser focused fact finding questions with confidence so these insurance exposures can be designed and solved for this market.  Keep in mind, this market includes Private Equity and Hedge Funds. They need to be asking probing risk management questions in order for these companies to fully understand their human capital exposure.  A by product of these fact finding questions will reveal the growing international exposure of their human capital risk.  This too can be protected for disability and life insurance.