Oct 24, 2017
Finding the right space to conduct your daily operations is important for any business, including emerging and high growth companies. Negotiating your lease is also crucial, as it governs the use of the space in which you run your business, where your employees work and where your customers or investors come to visit.
But leases can be complex, long-term commitments, so understanding the implications is important. This presentation by Osler Real Estate Group partner Paul Morassutti and associate Matthew Ritchie examines the nuances involved in negotiating a lease. Available in both webinar and PowerPoint format, the goal of this presentation is to help prepare you to navigate the following issues:
- why your lease is important
- deal terms – letter of intent vs. offer to lease
- implications of signing a lease for tenants and landlords
- financial covenants, inducements and operating costs
- relocation/termination of rights of landlord
- transfers and insurance
- events of default
- term and extensions
Negotiating Leases for Start-Ups from Osler, Hoskin & Harcourt LLP
For more information, contact Paul Morassutti, Partner, Real Estate Group, at email@example.com, or 416.862.6806, or Matthew Ritchie, Associate, Real Estate Group, at firstname.lastname@example.org or 416.862.5674.
This presentation is part of Osler’s Emerging and High Growth Companies 101 series, designed to help emerging ventures navigate through the various issues and legal requirements they will encounter throughout their growth cycle.
SPEAKER: I think we're going to get started. We've got a jam packed session with two topics here. So I want to get rolling. I'll just introduce the panel. For those who don't know me, I'm Simon [INAUDIBLE]. I'm an associate here in our merging companies and high-growth group, and pleased to introduce our panels. We've got Paul Morassutti and Matt Ritchie from our real estate group here at Osler, and [INAUDIBLE] from the founder of Zensurance, which is one of our clients. And they'll get into the details about what Zensurance does, but helping startups and small businesses with tailored insurance advice.
So we're covering two topics that I think a lot of these startups experience not a daily basis, but these are decisions that you may be faced with every couple of years or so. And they're important decisions because they affect the bottom line and the operations of the business. So we brought the expert in to give some tips and tricks and things to be thinking about when you're entering into these leases and purchasing commercial insurance. So I'll turn it over to Paul and Matt.
PAUL MORASSUTTI: Good afternoon, everyone. Thank you for coming. So negotiating leases for startups-- next slide. Let's start with, why is your least important? And this is actually a struggle that we have as lawyers, trying to explain why you actually should invest a little bit of time and effort in negotiating your lease.
It's a legal contract that governs the use of your space. It's the space where you run your business, your employees work, where your customers or investors come to visit. It sets out your rights and obligations. It also includes the costs that you're going to have to spend. And it also governs what happens if there's a dispute.
So I would like you to think of your lease as a marriage contract, not with someone you've been dating for a long time and want to get married to, but someone you just met. But you have to live with them for 5 or 10 years. You will have a relationship with your landlord.
Your landlord has way more money and power than you do. They're not going to want to treat you fairly. They'll barely tolerate your presence. All they want is your rent. And they don't want to hear from you. So if you have that mentality going into your lease negotiations, you'll have a better idea of what you're up against.
So the deal terms-- negotiating a lease is usually a two-step process. The first step is you want to negotiate your business terms. In Canada, the convention is to use binding offers to lease. It sets out the relevant business terms. But once you've signed that, you should have a binding deal. You may have conditions that let you get out of the deal, such as whether you need senior management approval, a tenant may want to first think about the cost of building out that space, the landlord may want to take a look at your financial stability and whether your covenant is good enough to pay the rent.
In the United States, it's a bit of a different approach which we're actually seeing more and more here in Canada. And in the US, the convention is to use non-binding letters of intent. They tend to be shorter documents, and you leave all the heavy lifting to actually negotiating the lease. But there's a risk with this because you don't have a binding deal. So the landlord can accept a better offer if that happens to come in between you signing the LOI and the actual lease.
However, it may present you with a bit of better leverage because when you actually get to the lease document, you're going to find that this is a very long, very landlord-friendly, and not a very user-friendly document. Commercial leases, certainly in the Toronto market, range anywhere from 30 to 70 pages. And it's single spaced, heavy on legal boilerplate. So that's the exercise that you'll now be entering into with the landlord.
So if you've signed a binding offer to lease, your leverage to negotiate this lease just drops dramatically. Whatever leverage you had now decreases. If you've only got a non-binding letter of intent, arguably you don't have a deal. So you can keep throwing the kitchen sink at the landlord and trying to get a better deal. It's basically a matter of preference. Either way works just fine.
From the tenant's perspective, very important to get your crucial deal points negotiated before you get to the lease. And our advice is going to be to focus on those items that will cost you money or interfere with your business. So at your stage, you're not really going to be taking half of First Canadian Place, so you're not going to be the gorilla tenant with mounds and mounds of leverage. So focus on the two things that we think are fundamentally important to you-- your money and operating your business.
And I'm now going to turn it over to Matt for what we think are the top 10 issues that you should consider in negotiating your lease.
MATTHEW RITCHIE: So the first issue we identified is the financial covenant of the tenant. The tenants are going to have to satisfy the landlord that they are going to be able to pay the rent due under the lease. As Paul mentioned earlier, that's all the landlord cares about. Is the tenant going to pay their rent?
As a startup, it may be difficult to satisfy the landlord in that regard. Landlords will typically require a deposit of two months rent-- first and last month's rent. The last month will be held until the end of the lease, often as a security deposit. And that's very common.
In addition to just providing first and last month's rent, many startups will also need to provide a higher security deposit or possibly a guarantor or indemnifier. They may also have to provide a letter of credit or prepaid rent. Now, a guarantor or indemnifier can be from a parent company. Or if that's not possible, the landlords will often ask for a personal guarantor. That's something that we would never recommend and always push back very strongly on. You never want to be liable for the obligations of an emerging company in a commercial lease.
The second issue we identified are inducements. Inducements include tenant improvement allowances, rent free periods, or other credits provided by the landlord to the tenant. They are payments made by the landlord to induce tenants into agreeing to lease their space. But the cost of the inducement plus interest at above market rates such as 8% to 10% is factored into the rent. So the tenants are ultimately paying the cost of the inducement with interest.
As these inducements are baked into the rent you're paying, they should not be forfeited unless the lease as terminated. Oftentimes, landlord forms of leases will state that if a tenant has transferred the lease-- and transfers very broadly defined-- or there's a default, even one that's been cured, you'll lose your right to the inducement. But that's something that we should push back on.
Often, to get inducements, tenants have to satisfy certain criteria before the landlord will pay the inducement. And the criteria can include the lease being signed, rent payments having commenced, the tenant occupying substantially all of the premises, the fact that no liens are registered against the building as a result of the tenants work in a lien period under the applicable construction lien legislation, which is provincial legislation has passed. And the tenant will be provided to give the landlord a statutory declaration from an officer stating all contractors have been paid and provide the landlord with proof of all costs.
Now, all of these requirements are fine. But for your inducement, it may be a significant payment. It might be $20 per square foot. It might be expressed as a value being $100,000, $200,000. And the key is that there should be no subjectivity baked into these conditions. As a tenant, you should know exactly when the landlord has to provide you with this money.
There can't be a condition on a prior transfer. And oftentimes, the landlord will also build in an arbitrary delay of 30 to 60 days. That should always be pushed back against. Once all the conditions are satisfied, there's no reason the landlord can't get your money back to you within a couple of days. And by giving them a longer time, you're just losing that little bit of interest on the value of your inducement.
But that just shows you how many little things in the lease are favored towards the landlord and not the tenant. And if you were to just sign a landlord form of lease, there's a hundred of these little cost drivers that you're just losing out on that the landlords will agree to if you ask them.
PAUL MORASSUTTI: And just to emphasize that point, those inducements-- they really are your money because you will be paying it back to the landlord with significant interest over the term of the lease. So the delay in getting your own money is just a cost to your business.
MATTHEW RITCHIE: Yeah. In theory, if you had no inducements, your basic rent should be lower. But unfortunately, that's not how landlords work. They'll give you an inducement instead of lowering your basic rent so you just have to work within the structure that they want to work within.
The next issue we identified is operating costs. Now, your rent is comprised of basic rent and additional rent. Additional rent is your operating costs, your realty taxes, management fees, admin fees, and any other expenses due to the landlord under the lease. We're going to focus here on operating costs. The landlord will flow all costs of operating the building to the tenants, usually in the proportionate share of the building. So if you have 10% of the building, you should be responsible for paying 10% of the cost of operating the building.
Issues arise when landlords attempt to include costs that are not direct cost of operating the building into operating costs. And we can include a list of standard exclusions into the lease to reflect the guiding principles described above that only the cost to operate the building are charged to the tenant. Usually, the biggest ticket issue with operating costs relates to the treatment of capital expenses. For
Example, if a landlord replaces the roof of their building, it may cost a million dollars, that costs should not be included in the year one while operating expenses. The cost of a capital expense should be amortized over its expected lifespan. So for a roof, it may be 20, 25 years in accordance with accounting rules. The first year portion of the capital expense is included in the current year. And the unamortized portion plus interest of such capital expenses is included in operating costs in future years. Amortizing capital expenses prevents a tenant from being tagged with an enormous expense, such as a $1 million roof replacement, which could happen in any year of the lease, including the final year.
PAUL MORASSUTTI: And again, just to emphasize that point, you need to factor, what are your gross lease costs? So if they say the rent is only $10 a foot, that's great. What are taxes? What are the maintenance fees? What is the condition of the building? Are they expecting capital expenditures?
Take a look around. If the place looks like it's falling apart, there will be expenditures coming. And you will be on the hook for those expenditures. So the goal here on operating costs is to reduce the risk of bad surprises. There will be some over the course of your marriage. Just try and keep them as few and far between as possible.
MATTHEW RITCHIE: The next component of additional rent that we're going to talk about here are management and admin fees. We're not going to talk too much about realty taxes because they are what they are. They're levied by the municipality. You're going to pay your proportionate share. And there's not typically too much room for negotiation there. So we'll focus on management and admin fees now.
Landlords charge a fee to compensate them for handling the day-to-day operation of the building. So this is a fee for the landlord to actually do the work to arrange for the roof to be replaced. Market standard management fees were traditionally 15% of operating costs, excluding realty taxes. The market standard recently has been shifting towards a different fee structure being 3% to 5% of all revenue receivable by the landlord. So all revenue includes basic rent and additional rent. It can include any fees the landlord gets from parking or from roof rights that it may sell. So this figure is typically a little bit more favorable to the landlord than 15% of operating costs, excluding realty taxes.
Some landlords have a management fee on operating costs plus an admin fee on revenues of a building. So you'll get a fee and then another fee on top of that fee and the basic and additional rent as well. A landlord should never have the right to add or amend the management or administrative fees throughout the term. This is particularly important if you're entering into a 5 to 10 year lease. We have seen that the management fees are shifting to be more landlord-friendly.
And they may do so within the next 5 to 10 years as well. So you do want to settle what that fee is going to be for the term of your lease in the lease document. You don't want to give the landlord the right to amend it and increase those fees. And again, the main takeaway here is you do need to consider these fees as well when you determine your all-in cost to lease a building or premises.
So at the end of your lease term, there are going to be obligations set out regarding the extent to which you have to repair or restore your premises. Leases typically provide the landlord with the ability to instruct the tenant which leasehold improvements or fixtures should be removed at the end of the term, or alternatively provide that the tenant should restore the premises to the base building standard. Tenants should always retain the ability to remove their trade fixtures, which are fixtures that are used to operate the tenants business, and their personal property-- so your computer you might bring in-- and try to eliminate end of term removal obligations or at least restrict them to non-standard leasehold improvements. Non-standard leasehold improvements would be something like the internal staircase you would see at Osler. That's not something that would be used by every business. But a demising wall between offices might be a leasehold improvement that is standard.
The tenant's maintenance and restoration obligations should always be subject to reasonable wear and tear. Obviously, within 5 to 10 years, the carpet isn't going to look as new as it did before. And you shouldn't have to replace the carpet just because you've walked on it.
Often, in landlord's form of leases, there will be a landlord right to relocate your premises or terminate the lease if the landlord wishes to redevelop the building. So a landlord might want to relocate your premises because you may only have 5,000 square feet of office space on a floor with 50,000 square feet of office space. And they may have a tenant that wants to come in and take the whole floor of a building. So they might want to move you to a different floor in order to accommodate that larger tenant.
You should know that a relocation will significantly disrupt your business. It'll cost you money. And you may get a different layout of your premises. Or you may get a different, less favorable external view. You might be on a lower floor as opposed to a higher floor.
If you see this clause in the lease, it's best to delete it. But if the landlord insists on including the clause, then you can insist that your relocated premises are substantially similar, which would mean they're not moving you from floor 20 to floor 2 and taking away your water view and giving you a high rise three feet from your window.
Your rent can't increase as a result of the relocation. And the landlord should be responsible for providing comparable leasehold improvements. So if you have brand new leasehold improvements in your current premises, they shouldn't be able to put you into new premises that haven't been repaired in 20 years.
All direct costs of a relocation should be the landlord's cost. So your costs of hiring movers to pick up your stuff and bring it to the relocated premises-- that's to the landlord. But the landlord's not going to pay for loss of revenue in connection with the relocation.
The right to terminate the lease should also be deleted. But if the landlord says, well no, I'm actually contemplating redeveloping the building. I may have to terminate this lease within the term. You do want to know that up front. And if that's the case, you should at least be given a significant notice period. We'd suggests 12 to 18 months. And this gives you time to find new premises and get all your ducks in a row so there's not too much of a disruption to your business and you're not losing out on very much revenue if you do have to do that.
Transfers and leases are a very important section, especially to emerging companies. So transfers typically require the landlord's consent. And there are several components to a transfer section in a lease. And there's things that the tenant should negotiate.
A tenant should negotiate the right to transfer the lease to affiliates or subsidiaries. You don't want the landlord to be able to block an internal reorganization three years down the road, or at least make it more difficult. You should also be permitted to change the control of your company, especially as an emerging company, within five years, the idea may be that you'll get bought out by a larger company. And you don't want to have issues with the lease if somebody does want to come in and buy your company.
Landlords may not agree to this, but it's something that you can always negotiate. You may include a clause that says the new company, after a change of control, will have an equal or greater net asset value. And that'll at least give the landlord some comfort that you're not going to enter into a change of control to take away all the assets of the tenant. A lease should always provide that the landlord can't unreasonably withhold their consent, and the landlord should not have termination rights upon a request for a consent to transfer.
You may also want to include a clause that you can share space with suppliers or tenants. You may have a company with some technology that you want to use come in and work in your premises for a month or two months in order to work together on a project that's going to be mutually beneficial for you. Oftentimes, tenants will just do this without telling the landlord about it. And normally it's not an issue. But it's always better to put this in the lease than risk the landlord noting you in default later on. Tenants should always ensure that there's no rights in the leases that are personal to the tenant. So if you do have the right to enter into a change of control or you have the right for a tenant improvement allowance or a rent free period, it should not be-- the right should not be extinguished because you've undergone a transfer in the past.
Now, the next component we're going to touch on-- and I'll be very brief because we have somebody that's going to know a lot more about this than we do-- is insurance. Our main point is that you should always consult with an insurance advisor to insure that you do get the insurance required under the lease. Briefly, from our perspective, insurance policy should contain mutual waivers of subrogation.
So the insurance company that pays the claim cannot sue the party that caused the damage or injury that required them to pay a claim. The intention is to have most risks insured by the landlord or tenant's insurance with no right of the insurer to come after the landlord tenant for reimbursement. The parties should also indemnify each other for all costs associated with risks for which they're to be insured.
Events of the default-- if there are events of default, the tenant should always be given an opportunity to cure the default. For monetary defaults, such as you don't pay your rent on time, you should at least have a very short window to cure this default. With electronic withdrawals from your bank accounts, it's unlikely there is going to be a default of rent. It's not like a check is going to be delayed in the mail and that'll cause you an issue. But if there is an issue, it's likely a computer glitch, and you should be given the opportunity to remedy it before the landlord can terminate your lease.
For non-monetary defaults, your cure periods should be longer, such as 20 days. But you should also provide that period to cure a non-monetary default can be extended if you're diligently pursuing curing the default and you do eventually cure it, because some non-monetary defaults will take more than 5 or even 20 days to cure. So as long as you're working towards curing it diligently and you do cure it, there shouldn't be a default or any remedies to the landlord. The landlord's remedies can include terminating the lease, suing for the present value of rent, distraining against your property, or suing you every month.
And the last issue in our top 10 list is the term and extensions of the lease. A typical term in leases is a five year term. But before you just accept the term the landlord gives you, you want to think about if that's appropriate for your business. Is this space only going to be used for a year or two and then it'll be too large or too small thereafter?
A term is always negotiable. So whatever your business needs are, that's what you should ask the landlord for. And the rent will likely be adjusted accordingly. You may get a lower rent if you enter into a 10-year lease than if you entered into a 2-year lease.
Tenants can often negotiate the right to extend the term for at least one five-year period. The extension rate should only be conditional on their not being a default beyond the applicable notice or cure period. It shouldn't be conditional on anything else, particularly there not having been a transfer or default that has occurred in the past.
And when you have this right to an extension, you want to make sure that you actually have this right and that the landlord can't use some arbitrary means to terminate it. So you want to say that the extension will be on the same terms as this lease, except for the base rent. The base rent will almost always be in the lease, or it should be the fair market value-- typically we'll see fair market value-- to be agreed upon by the landlord tenant.
Now, an agreement to agree is no agreement at all. That's where the landlord could say, well, I said I'd give you this extension on fair market rent. But I think fair market rent is-- and they'll give you a figure that's $10 above fair market rent. And you don't agree to it. So therefore, you have no right.
So you should build in a clause that says, if you can't agree on the fair market rent by a certain point, you go to arbitration. The fair market rent is determined by arbitration. And that's what you'll pay. And that will prevent the landlord from terminating your right without the requisite rights to do so.
So I hope we didn't go too far over our allotted time and we kept your attention. I know leases aren't always the most exciting documents in the world, but this will hopefully give you a bit of background when you do go to enter into a lease. I don't know, Simon, if we're taking questions now or all of the end.
AUDIENCE: I have a few questions now [INAUDIBLE].
AUDIENCE: I have one question on subleasing [INAUDIBLE].
MATTHEW RITCHIE: Yep.
AUDIENCE: Subleasing the office space from another tenant in the building and what kind of leverage do we have when negotiating it with a subleaser from the landlord.
PAUL MORASSUTTI: Very good question, because now you have two tenants, two landlords. So you have the head landlord with the existing tenant. And then the tenant subleases to you and you're the subtenant. Your contract is with the tenant, not the head landlord. So that lease that-- the head lease? No one's changing that.
You can negotiate your own business deal down below as a subtenant-- so rent, how much space. But the rest of the lease-- the insurance obligations, maintenance obligations-- that all will be governed by the head lease. And that's already in place. So whatever's there, you will be stuck with it. All you can really do is negotiate your business deal-- how much space, how much rent, how long you're going to stay there for. The rest is already predetermined by the head lease.
If there's damage that the head landlord is supposed to fix and it impacts the sublease space, you can't go to the head landlord because if I'm the head landlord, I'll say, I have no contract with you. Leave me alone.
AUDIENCE: Would you recommend to go to maybe renegotiate and deal directly with the landlord if possible?
PAUL MORASSUTTI: But subleases tend to have better rent deals. So if you want the better financial deal, you're going to be a subtenant. And if you need the head landlord to do something, you have to force the tenant-- your sublandlord-- to enforce the head lease. It's a bit complicated, but that's the way it has to be enforced.
If you want to do a direct deal with the head landlord, well, now you're not a subtenant anymore. Now you're a direct tenant. And you're probably going to be paying higher rent.
MATTHEW RITCHIE: A sublease will typically include a clause that says, the sub landlord will enforce the terms of the head lease on behalf of the subtenant upon a request by the subtenant. So that's how the subtenant can in practice get things done that they need the landlord to do. They'll have to go to the sublandlord, which can be annoying. But as Paul mentioned, you have no contract with the landlord.
PAUL MORASSUTTI: You always have the right to sublet. The lease will impose restrictions on how you can sublet. You'll always need to get the landlord's consent to do it. Can you carve out situations where you don't need consent?
Landlords will always say you can't sublet for less than that head rent or the head lease rent, which is ridiculous. In 30 years of practicing law, I think I may have seen one sublease where the rent was higher than the head lease. It's invariably the opposite.
So there are all these-- as Matt was saying, there's all these restrictions in a lease. A lot of them don't make any bloody sense. It's just leverage. It's just the landlord exercising far too much control over you as a tenant. So if you want to sublet some of your space, you still have your head lease with the landlord. If you want to sublet it for free, shouldn't matter because you're the one that has to pay the head landlord the rent under the head lease.
So that's another area where we could talk for an hour just on assignment and sublet rights. But again, if you know that-- if you're going to lock up 10,000 square feet of space because in five years you're going to grow into it but you don't need it until year three-- so year one and two you will be subletting-- that's something to negotiate upfront at the offer stage. So you got to think a few years ahead.
PRESENTER: OK. Over to the insurance expert.
SPEAKER: All right. Thanks.
MATTHEW RITCHIE: [INAUDIBLE]
PRESENTER: OK. So I'll give some context as to why you need to watch out when you buy insurance. And then there's a handful of types of policies that I've listed in here. I'll go through them quickly and give you a quick sense of what that policy covers and two or three things to watch out for when you're buying that policy. So as you're talking to a broker or any provider, there's maybe a 10 or 12 things you'll have in mind to watch out for to make sure you're buying the right type of policy.
So first, context is insurance. It's grown up as a completely intransparent market. So when you buy it, there's incentives on the side of the broker to not be fully transparent. So a couple of examples-- many brokers are owned by insurance companies. And so they have an incentive to sell you a policy from that insurer. If they're not owned, they might have a loan from there. They might have an equity investment from a particular insurer. So there's these biases in there.
They get compensated as a percentage of the premium. So there's some incentive to sell you a larger policy or pad it up in order to pad up their commission. And also small policies-- so small companies-- let's say under a million in revenue-- they're generally seen as an annoyance because the premium is so low. Even if they earn 20% on $1,000 policy, it's only $100, $200. And so there's not as much of an incentive to give you good service when you're that small. That's why you need to be a little bit more informed on your end so you can watch out for your rights, even if the broker you're dealing with doesn't want to spend the extra time on you.
The typical triggers for buying insurance-- one is a landlord. As we talked about, there will be certain things that are required. Second would be either a loan or an equity investment. That's typically a directors and officers policy. If an investor's coming on the board, they'll want that.
And quite often it's a big customer. We've had so many retail clients that start dealing with Walmart. And so they have to have a whole host of type of insurances before Walmart will deal with them.
Those are the three most common triggers. Some companies are proactive and say, hey, I've grown quite a bit. I have some employees now. Let me think about insurance. But generally it's a contract requirement.
We'll quickly run through-- maybe only to do that. One second. No, the keyboard. I can take this. OK.
Handful of policies-- I'll quickly go through each and talk about a few things. My lawyers have taught me to leave a nice little note there. None of this is insurance advice. This is just tips and tools. And if you need advice, talk to an actual licensed insurance broker.
General liability-- if insurance was Thanksgiving, this would be the turkey. It's the main policy. Most people start with this. It covers your office, your equipment, your computers, your laptops. The main thing for most companies is the product liability component. If you sell t-shirts and the t-shirt catches on fire or causes a rash, if you sell a hardware device and that hardware device malfunctions and burns down a house, that's the main thing here.
A few things to watch out for. We don't sell policies without the flood and the sewer back up in the top right hand thing. So that is a pipe bursts, Lake Ontario overflows, your toilet backs up. Half the claims on this type of policy is something related to water. So really watch out. Make sure that's in-- often, that's not there to save a bit of money, but make sure you get that in.
Also very, very important when you're getting insurance-- fully describe your business, what you're selling, where you're selling to, where you're importing your products. Because when you put that in, now it's the insurance broker's professional responsibility to make sure he or she sells you the right policy. Let's say they sell you a bad policy. You have a claim. That claim gets denied. You can always sue the insurance broker for selling you a bad policy. So once you've documented everything and you have it in writing, you're protected even if they sell you a bad policy. And as a broker, that's our professional responsibility to make sure we sell you the right thing.
Also sublimits-- often people will say, I want general liability-- two million. Great. There's probably 10 other things underneath it that might be at $100,000 limit, 500,000 or 750. So they might try and-- you might get lured in with a large number, but a lot of the actual coverages underneath are sublimited. So watch out. Generally, on the first page of your quote you'll have the top five things. Look at the numbers for all of them, not just the one big number at the top.
If you're dealing with the US and a client over their requests workers' comp, that's the equivalent of WSIB here. But we don't sell workers' comp here. There's a coverage in here called employer's liability. If you're a tech company, generally that suffices for what a client in the US would ask for when they say workers' comp. But ask your broker about that. You don't get workers' comp in Canada.
Professional liability-- this is probably the second most common type of policy. Often software companies will say, hey, we're not an advisory company. We don't need this. But in the insurance world, software is almost always seen as a form of service or advice. So much like a lawyer or a doctor has a professional liability policy, as a software company, you have the same.
So let's say you are a software that vets people before they're placed into an agency, a placement agency software. If you incorrectly vet, if your algorithm malfunctions and you place the wrong person, you can get sued for that. And this is the type of policy that protects you there.
The main thing we see here when you go to a big retail customer, they'll say, get us $5 million professional liability. We've even seen 10 million. We generally help our customers negotiate that down. So we were negotiating with a bank. They had some obscene limits. It would have cost us $20,000 to get that policy. We went back and we negotiated a lot of it down, down to about an $8,000 or $10,000 policy. So don't take it as a given. You can negotiate with customers.
Cybersecurity is probably the most misunderstood insurance policy that we sell. There's two parts. There's a first party cyber security. And then there's third party cyber security. Within each there's probably 20 types of coverages. And I'd say very few insurance providers truly understand what this covers and what are the drivers that will cause this insurance policy to actually pay out.
So a couple of examples-- first party are costs that you as the company, the purchaser of the insurance-- it's your own costs. So you must have heard a lot of the extortion or ransom type stuff that was happening in the last six months. A hacker hacks in, grabs all your data and says, I'm not going to give you your data back until you pay me a million bucks. Most insurance policies don't cover that. So that's an extortion or ransom coverage that it's good to have in there.
It could be fines or penalties. The government imposes certain penalties on you for being hacked, not being secure enough. So that's all first party.
The third party is let's say you have a software. And through you, your customer faces a loss. They hack your software, and through you they get into Amazon, or through you they get into the bank systems. That's third party. It's somebody else's loss that's caused by you. That's also something you should think about when you're getting this coverage.
Two major areas that we see as challenges when you're buying this policy-- the triggers. We want to make sure that the trigger is broad. Sometimes the policy only pays if you've actually been hacked. But what if an employee accidentally emails out the data? Some policies will cover that, too. So what's the trigger?
And the second is, what are the requirements you have to have in place in order for the policy to pay out? Most will say you must have a disaster recovery plan in place. You have to have antivirus software. You have to have weekly backups.
So there's a couple of things in there. You need to know what they are because otherwise, the policy is useless. And of course, there's an incentive on the insurance company's side to decline a claim, because it saves them money. So you want to make the policy actually covers it.
This one more than anything I'd say, whoever you're buying insurance from, make sure they truly understand your industry because cyber is not just about data. It applies in manufacturing as well. So for example, all the systems-- they're actually computers. If you get hacked, your systems go down. Your company's shut down. A cyber policy would cover that, not any other type. So whoever you're buying from, make sure they truly understand the type of business you're in. And so the triggers and the limits-- they'll have a sense for what you need.
Management liability-- the biggest trigger for this is an external investor that's going to come on your board and they say, you must have directors and officers. Generally it's either a $1 or $2 million liability limit. If you're a small company, this is probably $1,500 to $2,000 a year. 70% of the claims on policies like this are from the employment practices side-- unfair termination, sexual harassment, the employee thought they should have gotten promoted but they didn't, they felt they should have gotten a raise but they didn't. So even if you don't have an external board of directors, you should get it specifically for that coverage. After about 5 or 10 employees, we generally see companies starting to get this for that purpose.
The second most common claim here is investor disputes. You do another round of funding. An old investor says, hey, you unfairly diluted me. I'm going to sue the company. Or we give you $3 million and you spent it on this big initiative and you made a big loss and you're going bankrupt. The investors sued because you wasted $3 million. So that's the second most common here.
Generally, early stage companies-- insurers will try and put a bankruptcy exclusion. And you do not want that in there. The bankruptcy exclusion is, any lawsuits driven by a bankruptcy of the company are excluded. You do not want that in there. They'll generally try to put it in if you have less than 12 months of cash in your bank account. So that's a good threshold to have. Have 12 months of your burn rate in your checking account, or some sort of liquid assets. You'll get a better rate, and there will be no issues with that exclusion.
Auto-- we don't see this is quite common for startups. Generally they won't have their own commercial auto. But if you have auto in the company's name, you'll get this policy. If you have five or more autos, you qualify for a fleet discount.
Most often we see people using their personal vehicles for business purposes. If you do that, your claim may not actually cover you, especially as the owners of the business. There is a coverage called non-owned auto if employees. So not owners, not principles, but if employees use their personal vehicle for business purposes, that could be covered.
The thing to watch out for here-- let's say you're at the office and an employee runs out to buy lunch for the team because the team is working over lunch. She uses her personal vehicle and gets into an accident. Her personal vehicle insurance has the right to decline the claim because the vehicle is being used for business purposes, not for personal uses. So you've got to watch out when you're using personal vehicles for business purposes. There's a coverage called non-owned auto for that purpose.
Finally, crime. I think this my last one. It's not too common, but it is quite-- it's more common when you're a fintech company and you're processing payments or you deal with cash or valuables. There's third party and first party.
So if you're dealing with cash and an employee steals from a customer, that's a third party crime. We've insured a couple of companies that do payment processing transactions. Their risk would be an employee put some code in there. For every transaction, they yank out a one cent or two cents. That would be electronic crime, so you want a policy for that. Or first party-- if you're dealing with cash in a retail outlet and your employees steal from the company-- so that's what that would be for.
Quite often when you deal with banks, automatically they'll put a requirement for crime insurance. If you're not dealing with fund transactions, you can negotiate that requirement away. This is typically a $3,000 or a $5,000 per year policy. So if you don't need it, try and negotiate it away.
Some top level figures for pricing-- I went through the numbers of all of our clients and looked at different sizes and types. If you're not doing anything crazy, for instance launching satellites or processing payments or in the medical field, generally this is the amount you would expect to pay. If you're a tiny seed, very early stage, almost no revenue, $400 to a $1,000 a year for the types of policies that are relevant for you. If you're a little bit bigger, approaching series A, you're paying between $1,000 to $3,000 or $4,000. If you're larger probably, a million, two million. Most of our clients fall into the $4,000 to $6,000 range for a basket of policies.
If you're larger than that, of course it scales. If you're doing something really complex or high risk, it's different. But I'd say 70% of our tech customers fall into one of these categories or off the charts. I'll pause for questions.
AUDIENCE: Considering I got a quote of $20,000, [INAUDIBLE].
PRESENTER: It really depends on what you're doing. We've done $60,000 policies. We've done $200 policies. It really depends on what you're doing. Even though I'm in the insurance field, I know it's a really boring topic. It's not interesting. And it's generally painful. So most people will just buy it, forget about it, and deal with it on renewal.
But if your business changes meaningfully mid-year, you really should be updating your policy and checking to make sure everything still works. So for instance, if you're a product company only selling in Canada, all of a sudden you sell into to the US, your insurance policy may not cover that. So it shouldn't be just an annual thing. Periodically just think about, has your business meaningfully changed? And adjust if needed.
AUDIENCE: What companies can do to lower cost of service?
PRESENTER: Yeah. So the biggest drivers of cybersecurity insurance is the number of records you hold-- customer records-- and the type of record. So that's the driver. What you can do to reduce your cost? In short, it's protect it better. So have daily backups. Make sure you have all of the right firewalls and other things set up. Make sure you have periodic testing of things.
So the more secure you can make the data-- the more you convince your broker to convince the insurer that you're a safe risk, the better the rate you would get. And of course, then, changing how much you're buying changes the price.
SPEAKER: All right. Thank you very much.
SPEAKER: So we've stayed on time. I'm impressed that we've stuck to the schedule with two topics. I wasn't sure if we were going to go over. So a couple of administrative announcements-- on your tables, you've got feedback forms if you can just do us a favor, take a couple of minutes, and fill that out. The feedback we get it's very valuable for planning future sessions and topics that you think are interesting or that you're thinking about are helpful to share with us.
Our next session is November 20. We're going to be covering debt financings. And we have a guest speaker coming in for that. So look out for the invite in the next week or so. And I guess if you can stick around a couple of minutes at the end if anyone has further questions, Matt and Paul and Dan can answer those if you have specific questions and want some free legal advice. So thanks again.
PAUL MORASSUTTI: That was well done.
PRESENTER: Thank you. Thank you.