You are staring at a twenty page contract. Deep in section fourteen is a dense paragraph about indemnification. It looks like a wall of text designed to be ignored.
Most founders skim this section.
That is a mistake. While pricing and deliverables get all the attention, the indemnification clause is often where the survival of your company is decided. If you sign the wrong agreement, you might be putting your entire business on the line for a mistake you did not even know could happen.
The Core Concept
#Indemnification is a legal agreement where one party agrees to pay for potential losses or damages caused by another party. It is often referred to as a “hold harmless” clause.
Think of it as a mechanism to shift risk.
In a business relationship, things go wrong. Someone gets sued. Data gets lost. Intellectual property gets stolen. When these bad things happen, someone has to pay the legal fees and the damages. The indemnification clause dictates who pulls out their checkbook.
If you indemnify a client, you are promising to shield them from specific harms. If a third party sues your client because of something you did, you step in. You pay the lawyers. You pay the settlement. You absorb the blow so the client does not have to.
Common Scenarios for Startups
#You will face this clause in almost every serious business interaction. It usually appears in three specific contexts.
- Service Agreements: You build software for a client. You accidentally use code that belongs to someone else. The copyright owner sues your client. Your client looks to you to cover the costs.
- SaaS Contracts: You run a platform hosting user data. You suffer a breach. Your customers want you to indemnify them against claims arising from that leaked data.
- Board of Directors: You ask people to sit on your board. They will ask for indemnification. If the company gets sued, they do not want their personal assets at risk for decisions made in the boardroom.
Indemnification vs. Limitation of Liability
#It is impossible to discuss indemnification without looking at its partner. That partner is the Limitation of Liability clause.
Indemnification defines what you are responsible for. Limitation of Liability defines how much you have to pay.
These two clauses fight against each other. In a negotiation, a large enterprise client will want broad indemnification from you. They want you to cover everything. Simultaneously, you want a tight limitation of liability.
You want to cap your exposure. If your contract is worth fifty thousand dollars, you do not want to be on the hook for five million dollars in damages. The interplay between these two sections is often the most contentious part of closing a deal.
Why It Matters for Your Startup
#The danger for early stage companies is asymmetry. You are likely dealing with vendors or clients who have significantly more cash and legal power than you do.
If you agree to uncapped indemnification, you are effectively betting the company on that single contract. One lawsuit could bankrupt you.
As you review these documents, you have to ask yourself hard questions. Do you have the cash reserves to back up the promise you are signing? Does your professional liability insurance cover the specific indemnity risks you are accepting?
Every founder wants to close the deal. But you must ensure the deal does not contain a poison pill that kills the company years down the road.