Got Insurance? Lawsuit Exposes Need

A recent lawsuit by three of the co-founders of against Benchmark Capital, August Capital and BV Capital may be causing VC firms to revisit their insurance needs.

Typically, venture capital asset protection policies, or insurance policies and related products, cost about $100,000 yearly and come with deductibles that range between $250,000 and $500,000, meaning that they aren’t much help until a major incident arises.

One concept that appears to be gaining traction in the VC industry is that of the captive entity, an insurance firm formed by a company to protect itself exclusively. Though Fortune 500 companies such as Microsoft Corp. have for decades used captive entities, VCs are beginning to think that they’re a pretty good idea, too.

“The insurance industry is great at creating astronomically expensive products that don’t involve much of a payout,” says the CFO of a San Francisco-based VC firm that’s finalizing how its own captive entity will be structured. “Worse, when you have a claim, your premium goes up the next year by 100%. We’re using [our own insurance] to fill a gap.”

Indeed, Mike McKee, founder of Private Equity Risk Management, a former partner at the fund-of-funds firm Pacific Corporate Group, is hoping to launch a new career around that gap.

PE Risk Management is currently in discussion “with 20 firms, 10 of which are interested” in setting up captive entities, says McKee.

There are many advantages, he says. For one, because the firm is insuring itself, if no claims are made against it, the money that it has poured into the entity goes back into the coffers of a firm’s limited partners.

Also, a captive entity allows a firm to elect a higher deductible when renewing its asset protection policies, saving itself money. Finally, though not a point that McKee promotes to VCs, he says, operating a captive entity allows a VC firm to circumvent a layer of insurance brokers when purchasing its asset protection policies from a carrier, which can cut costs on those policies by anywhere from 10% to 25%, he says.

It is unclear whether Benchmark, August Capital or BV Capital operate their own insurance arms.

The suit against the three firms was filed two weeks ago in San Francisco. It claims the VCs cheated several co-founders of the consumer product review site Epinions out of millions of dollars.

The suit also names partners Bill Gurley, John Johnston and Thomas Gieselmann, from Benchmark, August Capital and BV Capital, respectively.

“The suit is completely without merit, and we will defend it vigorously,” says Steve Spurlock, Benchmark’s operating partner. “We are confident that the ultimate resolution of this matter will be based on a true and fair reading of the facts and that the allegations will be proven to be baseless.”

Epinions founders Naval Ravikant, Ramanathan Guh and Mike Speiser, as well as 40 former Epinions employees, brought the lawsuit against the three VC firms. The suit claims that the VCs conspired with Nirav Tolia, one of the startup’s five founders, to withhold critical financial news that would have drastically altered the value of the founders’ shares.

Those shares were valued at zero when Epinions was merged with comparison-shopping site DealTime in 2003.

But 14 months later, the founders say that thanks in part to new information – concerning a profitable deal with Google Inc. – the combined company, went public and Tolia received a windfall, along with the VC firms.

On the day of the IPO, Tolia, along with other Epinions employees, held shares totaling more than $37 million. At the same time, August and Benchmark were each sitting on shares worth more than $60 million.