Insurance for PE&VC Fund Managers

Recent political and economic events have changed the landscape for private equity and venture capital firms. Hence, private equity-firms have become more vulnerable to lawsuits, which can be expensive to defend and even more costly to settle. Litigation threats are arising from portfolio company bankruptcies, dissatisfied investors and regulatory investigations.

They pose new levels of risk to private equity and venture capital firms, as well as to the personal assets of their managers and employees. Even though, fund managers or general partners can protect themselves from direct demands of investors by contractual means, an agreed indemnity in the event of gross negligence may be void.

The revised Swiss Collective Investment Schemes Act, aiming at equivalence with the new EU Directive on Alternative Investment Fund Managers (AIFM directive), have specified the standards for the fund managers' professional liability.

The regulation’s detailed definition of professional liability risks, however, is neither meant to be complete nor exhaustive. Indeed, the fund manager shall implement effective procedures in order to identify its own specific risks related to its professional liability.

Board representation
Claims filed against portfolio company board members can originate from various sources: company, competitors, suppliers, vendors, governmental/regulatory agencies, company employees and management as well as other board members. An individual can be sued in his capacity as a board member of a portfolio company or in his capacity as an investment advisor. Also, under the “control person” legal theory, board representation presents liability exposures for the general partner and the fund. D&O liability cover (preferably part of an investment management insurance) can protect those individuals representing the PE/VC-firm on boards of invested companies.

Fund management
Limited partners expect general partners to manage the fund according to guidelines outlined in private placement memorandums. Investors expect due diligence, good faith, loyalty, care and other fiduciary duties from general partners. Lawsuits can be filed when it appears that any of these responsibilities have been breached. Although partnership agreements provide protection for the general partner, such indemnification can be circumvented by lawsuits alleging general partner gross negligence. Investment management insurance can cover liability risk exposures related to fund management.

Deal evaluation
When a prospective deal collapses, portfolio companies assert allegations seeking damages from lost financing opportunities and the misuse of their proprietary and confidential information, i.e. the portfolio company was “strung along” by the VC/PE firm.

Employment practice
Members of the portfolio company’s management team may have been replaced post-deal, creating potential claims for wrongful termination. These claims implicate VC/PE firms especially in Common Wealth and EU Countries.

Offshore structures
Offshore funds are often part of the investment solution for structures initiated in Switzerland. Therefore, in addition to 'indemnity' or ‘hold harmless’ agreements between the fund and its manager, it needs to be considered whether a foreign insurance policy (e.g. out of Switzerland) is admitted in the offshore jurisdiction concerned, to compensate the fund or its directors.

Fund’s investment returns at risk?
Consider the fund’s risk. A general partner's liability is often guaranteed by the partnership agreement’s indemnification provision (except for gross negligence). However, when third-party suits are filed against the general partner and/or the partnership, the fund may ultimately become responsible for defence/legal costs, judgments and settlements. Such claim expenses may likely reduce the fund’s investment returns. Not without reason, the European Venture Capital Association (EVCA) affirms in their Guidebook that 'the manager may also take out insurance that affects the fund's ability to give warranties and indemnities.'


M&A-Risk - W&I-insurance as a strategic advantage in a competitive bidding-process
A critical step in the sales and purchase process of a portfolio company is the risk allocation between the contracting parties, i.e. purchaser and vendor. Corporate buyers often encounter difficulties due to the lack of enforceability of seller warranties and a low credit rating of the vendor, which cannot be compensated by a lower purchase price. The warranties & indemnities insurance (W&I-insurance) provides a high strategic value and competitive advantages for the buyer and the seller. From a financial perspective, W&I-insurance is particularly effective, if the premium is lower than the purchase price discount requested by the buyer for not insisting on certain warranties and/or indemnities. Using M&A-insurance solutions, deal breakers can be overcome, eventually leading to a win-win-situation for all parties involved.