Indemnification refers to shifting onus and responsibility between parties. If you borrow my car and indemnify me against your use of my car, if you hit someone, they can’t sue me. In simpler terms, you’re offering me protection or insurance against claims (gratis, of course).
In a private equity term sheet, indemnification most often refers to the company indemnifying the board and investors against any cases brought against the company. This is a standard term that private equity firm will rarely (never) negotiate. With that said, it’s a reasonable term given that directors hold advisory rather than operational roles. You could debate otherwise, but abolishing the term would mean you attract far less directorial talent. You’d be hard pressed to find quality directors willing to join your board without indemnification.
In addition to the indemnity term, private equity firm will often require directors and officers (D&O) insurance. As with most insurance, it’s important that you understand the nuances of the policy, because you may find you’re not covered for obvious events. And if you’re a CEO who is also on the board, then you are also covered and should particularly attentive to the policy wording. Just as the limited liability structure of a company doesn’t protect against everything, neither does a D&O policy.
While indemnification is a standard non-negotiable term, consider how indemnification affects the rest of your business. Entrepreneurs without legal nous often sign contracts without understanding the full extent of indemnification. You may think you have minimal exposure, but you must also consider the exposure of the other party. That’s what’s really in play here. And when it comes time for someone to sue, it’s all about the deepest pockets, which hopefully are yours, if all is going well.
Rather than get too obsessed, just keep an eye/ear out for the term indemnify. If it appears in anything you’re about to sign, pay particular attention. People have lost everything by unknowingly (or unconsciously) indemnifying others.