From a startup with a few employees to a publicly traded company with hundreds of employees, tech companies vary in size and can grow rapidly. With this growth, a tech company’s insurance needs will likely change. That’s because more growth can present different risks and challenges.
What Makes a Tech Company Grow So Quickly?
One of the factors behind a tech company’s rapid growth is venture capital funding. These firms raise capital to invest in startup companies. The firms’ goal is to eventually sell their stakes and earn a return for investors.
Venture capitalists invest in businesses for many reasons, like:
- Stronger returns compared to the S&P index. There’s typically between a 12% and 15% internal rate of return over the fund’s lifetime.
- Portfolio diversification for higher risk and return assets.
- Strategic investment to gain knowledge and influence over emerging technologies.
Even a global pandemic didn’t affect venture capital funding. In fact, throughout the world, venture funding was up to $300 billion in 2020 – a 4% increase from 2019.1
While venture capitalists invest in every industry, they’re attracted to technology startups because of the potential for scaling, high margins, recurring revenue and long-term growth. All of these factors can be accelerated with upfront investments.
The Venture Capital Firm Structure
General partners or managing directors lead venture capital firms. Firms typically have a team of principals and analysts to help with operations. The firm is responsible for performing administrative functions for funds it manages, like:
- Accounting
- Legal
- Marketing
- Investment diligence
Each fund consists of a general partner and one or more limited partners. General partners make all investment decisions and oversee fund operations. Limited partners provide capital, but don’t have decision-making authority and no fund-related liabilities if things go poorly.
Venture capital firms make money after they exit a fund. This can happen with:
- IPO or other public offerings. If a company grows large enough, it may go public on one of the stock exchanges. Having at least $100 million in revenue is seen as a milestone for going public.
- Reverse mergers. Instead of going through a traditional IPO offering, a special-purpose acquisition company (SPAC), or a “blank check” shell corporation, is created to take the company public.
- Strategic acquisition. A larger company may buy a business to acquire a technology, product or team. Large acquirers in the technology industry include Amazon, Apple, Google and IBM.
- Buyouts. This is similar to an acquisition, but it’s less strategic. A venture capital-backed company may get bought out by another company to add to their portfolio.
How You Can Protect Your Tech Company as It Grows
Tech companies grow in stages and each one brings new, more complex risks. Insurance can help provide the security you need to keep innovating and growing.
“The risks a tech company faces when it’s in growth mode is drastically different than when it was a startup. There may be more employees or different products than when the company first started – all of which can bring liability risks,” said Andrew Zarkowsky, Technology Industry Practice Lead at The Hartford. “Having the right insurance coverage at each stage can help prevent any costly surprises if something unexpected happens.”
We’ll use a fictional tech company as an example to explain this growth and what a business typically deals with at each stage. Alex and Becky are coworkers who come up with an idea to start a tech company.
Learn what each stage of growth looks like for their company and the insurance coverages they can consider to help protect their business.
Angel or Pre-Seed Phase
Scenario
Alex and Becky write a business plan and get feedback from trusted mentors. They decide to start their business with investments from their savings and close friends. They also build a prototype of their product. To create the first version of it, they anticipate needing about $100,000 for development, research and refining the business plan.
The first stage of funding is the angel or pre-seed phase. Founders fund their startup with their own money or with capital from friends and family. Sometimes, they may pitch their idea to angel investors to secure funding.
At this stage, a tech company doesn’t typically have liabilities, assets or contracts that would require insurance coverage. Buying insurance coverage is a proactive measure to provide peace of mind.
Seed Phase
Scenario
Alex and Becky quit their jobs to focus on their new company, A&B Corp. They spend six months to test an early version of their pilot. They make tweaks to their product based on positive feedback and customer use cases. They put together a model and believe they can make a finished product and grow their business with $2 million. The money can help them hire two more developers and another person to help with sales.
Becky’s friend works in venture capital and introduces the business owners to a few firms. A&B Corp raises $2 million at a $7 million pre-money valuation. Alex and Becky are able to grow their development, sales and marketing team with the new capital.
Think of this stage of growth as the tech company now becoming “official.” A tech company is developing minimum viable products or establishing product-market fit. The team at the tech company is still very small and usually includes the founders and a few employees, like engineers or development staff.
Funding is typically between $100,000 and $2 million. It varies depending on the type of tech company, and because of the size of the tech company, its valuation is small.
Insurance coverage for this stage of growth can typically be addressed with a Business Owner’s Policy (BOP). Workers’ compensation insurance (WC insurance) is also important to help employees recover from a work-related injury or illness. Cyber insurance may also be essential because tech companies can be the target of cyberattacks. Handling sensitive or personally identifiable information (PII) can put your tech business at risk of a breach or attack.
Five Stages of Growth: See How Tech Companies Evolve Over Time
Tech companies often grow quickly because of support from venture capital firms. Learn more about each round of fundraising below:
1: Angel or Pre-Seed Phase
Startups are typically funded by their founders' and co-founders' personal capital. In some cases, founders may reach out to friends, family or angel investors to get more money. But at this stage, their product or service is still just an idea.
2: Seed Phase
Companies have small teams that focus on creating minimum viable products and establishing product-market fit.
Funding Raised: Between $100,000 to $2 million
Company Value: Small
Funding Raised: Between $100,000 to $2 million
Company Value: Small
3: Series A
At this stage, the company has established product-market fit and has early revenue traction. They've also appointed a venture capital firm as the lead for their fundraising.
Funding Raised: Between $2 million to $15 million
Company Value: Around $20 million
Funding Raised: Between $2 million to $15 million
Company Value: Around $20 million
4: Series B
Companies have at least one established product, experienced revenue growth and traction.
Funding Raised: Around $30 million
Company Value: $50 million to $60 million
Funding Raised: Around $30 million
Company Value: $50 million to $60 million
5: Series C or Later
This stage is similar to Series B but the company has a higher value. Investors may refer to this stage as the "late stage" or "growth stage."
Funding Raised: Around $70 million
Company Value: $100 million or more
Funding Raised: Around $70 million
Company Value: $100 million or more
Series A
Scenario
A&B Corp. signs up 10 new customers in a six-month period. The business needs more capital to sustain growth. To help with this, they need to increase their development capacity. Alex and Becky have been too focused on customer service and can’t spend time on growth. They want to hire a sales and operations leader who can work to grow the company. They also want to develop a new product that can expand their Total Addressable Market and give them upsell opportunities with customers. To do all of this, they need an $8 million Series A funding. A&B Corp. ultimately accepts a term sheet from their investment partner, Venture.
With Series A funding, the tech company has an established product-market fit and early revenue traction. Capital raised during this stage of growth is used for hiring talent, typically in engineering or sales and leadership.
The Series A fundraising rounds are more formal at this stage. Venture capital firms usually lead the fundraising. The lead investor takes a seat on the company’s board. Other investors can join the board as observers or members, depending on the amount invested or their strategic value to the company. The amount raised varies but can range between $2 million and $15 million. The valuation for companies needing Series A funding is often around $20 million.
Because of their size, companies often move to a more sophisticated insurance program. These typically have enhanced business liability coverages, including commercial auto insurance and umbrella coverage with a small limit.
Some insurance coverages you may want to consider include:
- Professional liability insurance
- Liability insurance for large businesses
- WC insurance for large businesses
- Business income insurance
- Property insurance for large businesses
Series B
Scenario
Over the last 10 months, A&B Corp. has grown significantly. The business moved into a larger office space to fit its growing team. As a result, operating expenses have increased. Sales growth has started to slow as their first two products lines penetrated most of the market. Leadership has been discussing a new product that can double their addressable market and they also think there’s an opportunity to acquire a smaller competitor. West Coast Capital offers the business $30 million Series B funding at a $60 million pre-money valuation. With this capital, they can grow A&B Corp. and plan to acquire the competitor. They also expect to hire 40 new employees over the next six months.
Series B funding is similar to Series A, but the amount is larger. The average round is $30 million. Company valuations at this stage of growth are between $50 and $60 million. Capital is used to mature the company through:
- Building out sales and development teams
- Investing in customer acquisition and care
- Professionalizing management teams
- Investing in other areas of the business that need attention
A tech company that is looking for Series B funding has at least one established product and possibly a product or technology roadmap, as well as strong recurring revenue.
Investors from earlier rounds may choose to “follow on” and invest more capital. There also can likely be a new lead investor during this stage.
At this size, businesses typically have contractual and first-party needs for:
- Professional liability insurance
- Cyber insurance
- WC insurance
- Commercial auto insurance
It’s likely that businesses of this size will need to increase their coverage limits to provide more protection. For example, as a business grows, there may be more company property that requires higher coverage limits. So, increasing limits on a commercial property policy may be needed.
Series B funding will also require directors and officers (D&O) insurance coverage to help protect the board.
Series C
Scenario
A&B Corp. expanded its footprint and now has locations in New York City and Denver, as well as its headquarters in Hartford. Given their tremendous growth, the team is considering an IPO in the next few years. The company expects to pass $50 million in annual recurring revenue this year and to be cash flow positive by the first quarter of the following year. The team decides to raise a $70 million Series C round at a $500 million pre-money valuation to help sustain this growth and get to an IPO. A&B Corp. will use the capital to expand overseas and to acquire and invest in startups in the market.
Businesses at this stage have higher valuations of over $100 million. Funding is also larger and the company is more mature. Investors may refer to these tech companies as “late stage” or “growth stage.” The focus is on expansion.
Because of the size and complexity of the tech company, they need an insurance policy that’s tailored and unique to their business. Higher coverage limits are preferred to provide greater protection for the business.
Businesses should review their technology professional liability insurance to make sure they have proper coverage for this stage. Policies should include software copyright, media and first- and third-party cyber coverages.
Tech companies may also need multinational insurance for international locations or if employees travel abroad. This is an important coverage because most standard business insurance policies won’t cover foreign claims.
Understanding the Unique Needs of Tech Companies at Every Stage
Regardless of where your tech business is in its growth cycle, insurance coverage is important. Partnering with an insurance company that truly understands the unique needs of tech companies is essential. We’ve worked to understand how tech companies grow and the risks they can face at every stage. And we’ve created specialized insurance solutions to help give tech companies better outcomes and opportunities for success.
Learn more about our tech insurance offerings and work with your agent or broker to see how we can help protect your company.
1 Crunchbase News, “Global VC Report 2020: Funding And Exits Blow Past 2019 Despite Pandemic Headwinds”
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