“Killer pitch. Your team is strong! I believe there’s a lot of market potential for what you’re building. I’d like to bring this opportunity to my Monday morning partners’ meeting. Could you send me a link to your data room?”.

“Of course! I’ll send it right away!”.

The Zoom call ends. You turn to your co-founder and ask, “what the heck is a data room?”. With a puzzled look on her face and shrugged shoulders she replies, “I dunno…but we’ve got 48 hours to figure it out!”.

The above situation is commonplace for most early stage founders pitching VCs for the first time. As a founder, you know the importance of a killer pitch and a strong team. But what about a well-prepared data room? With this guide, you’ll be equipped to understand the purpose and importance of a data room, and how to create a winning one for your startup or business. And for early stage investors, we’ll provide an in-depth look at the latest trends and best practices when reviewing a potential investment’s data room. So grab your coffee, and let’s dive into creating a data room that will take your pitch to the next level.

What is a data room?

The term "data room" originated in the M&A space of the 19th century, long before the advent of modern computing. In those days, when a company was up for acquisition, M&A teams would set up a physical room filled with filing cabinets containing sensitive documents and information on paper. These rooms were often heavily guarded, with strict security protocols in place—no photos, no photocopies, and access only through scheduled appointments under supervision.

Creating these data rooms was a game changer for the M&A world, but maintaining physical spaces came with its own challenges. They were expensive, cumbersome to navigate, and prone to risks—imagine a sleep-deprived M&A analyst accidentally setting fire to a decade’s worth of financial statements!

Today, a data room refers to a secure online repository where companies can store and share confidential information, typically during due diligence processes in mergers and acquisitions. Unlike their physical predecessors, modern data rooms are designed for ease of access and enhanced security. They allow authorized users to upload, manage, and share documents while tracking activity in real time. This digital transformation has made data rooms essential tools for startups, facilitating streamlined collaboration and ensuring that sensitive information remains protected.

The rise of Virtual Data Rooms (VDRs) and Online Data Rooms

With the proliferation of technology and the internet in the late 80s, Virtual Data Rooms (VDRs), also known as deal rooms, quickly became the new norm. A VDR is simply a secure online repository for document storage and distribution. The ethos of today’s modern VDR solutions remain the same as data rooms from the analog days. There’s still an emphasis on security and permissions but rather than paid guards and pad locks, they use multi-factor authentication, read-only permissions, and digital watermarks.

The role of data rooms in early stage venture deals

In early stage venture deals, data rooms play a critical role in two stages of the investment process.

During stage 1, it’s not uncommon for an investor to ask to see a company’s data room prior to offering a term sheet. At this stage, the investor typically doesn’t have much to base their investment off of aside from a pitch deck, the company’s website and any publicly available information they can find on the internet. Investors use stage 1 data rooms as a spot check and often leverage the information in the data room to conduct a conversation internally amongst their fellow partners.

Stage 2 typically comes after a founder receives a term sheet and is used to help streamline the due diligence process, by providing investors access to a much more granular detailed set of information and documents.

A startup data room checklist ✅

A well-structured data room can significantly streamline the due diligence process for startups seeking investment or partnerships. Here’s a checklist of key components to include in your data room:

How to structure a stage 1 data room

Reminder: the goal for investors during this stage is to conduct an initial spot check to make sure your pitch and your numbers match. Did slide 5 of your pitch deck say you had $10K in MRR as of January? Well you better have the financial statements in your data room to back it up! 

They’ll use your data room to create a deal memo or have a conversation amongst the partners to decide whether they want to offer you a term sheet. Your goal as a founder is to make your investors' lives easy…the more an investor has to dig to uncover the right information, the less likely they’ll invest.

Here’s a list of the 5 sections and types of content you’ll want to include in your stage 1 data room:

Done right, your stage 1 data room should be simple, clean and look something like this:

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Sharing your stage 1 data room

What’s the first rule about sharing data rooms? We don’t talk about sharing data rooms…unless a vetted investor whom we trust asks for access. You’re not going to get bonus points for prematurely sharing your data room or offering to share it immediately following your first 20 min investor intro call. In fact, sharing your data room prematurely or including too much information within your data room could actually hurt your chances of investment.

When should you share your stage 1 data room? Typically you will have had a conversation or two with an investor, you’ve vetted him or her, and you trust them. If they ask for it, go ahead and share it.

Who should you share your stage 1 data room with? Trusted, vetted venture investors. Use free resources like crunchbase.com to do your own due diligence. Are they legit? When was the last time they announced a fund? Do they have a good track record? Is your main competitor one of their portfolio companies? These are the questions you should be asking yourself before you share any sensitive information with any investors.

Should I share my stage 1 data room with angel investors? It’s atypical for an angel to ask for your data room unless they’re writing substantial checks north of $100K. Again it comes down to trust…if you trust the angel, no harm done in sharing.

How should I share my stage 1 data room? VDR platforms built for early stage founders like DataRoomLink.com have permissions controls built in. By default you should always turn on read-only permissions at this stage in the investment process. Ensure read-only permissions are enabled, add the investor’s email to the allow-list, and send the investor a follow up email with an access link.

How to structure a stage 2 data room

Reminder: Stage 2 typically comes after you’ve received a term sheet from a potential investor, you’ve negotiated on those terms, and want to move forward with the investment.

At this stage, it’s all about streamlining the due diligence process. Remember, term sheets typically aren’t legally binding documents…your company is still subject to due diligence before any final agreements are signed and funds are transferred to your bank account.

During this stage, you’ll want to add additional resources to your stage 1 room or better yet, copy your stage 1 room to a completely new data room. Keeping your stage 1 room and stage 2 rooms separate allows you to have better control and flexibility. Not all of the investors you pitch will be in sync from a timing perspective. You might be at stage 2 with a16z but at stage 1 with Accel so maintaining two separate rooms with different levels of detail and permissions is beneficial.

Note: It’s not uncommon for a venture capitalist to provide founders with a checklist of due diligence request items at this stage. This list is sometimes called a due diligence questionnaire (DDQ).

Here’s a list of additional sections and content you’ll want to include in your stage 2 data room:

Sharing your stage 2 data room

What’s the first rule about sharing data rooms? We don’t talk about sharing data rooms! That’s right, the same rules that applied to sharing your stage 1 room, apply here as well. Unless you’ve received a term sheet and you’re asked to share (and you will be asked if you’ve received a term sheet and decide to move forward) don’t share it until it’s requested.

The only major difference between sharing stage 1 and stage 2 data rooms is that at stage 2, investors will likely want to make their own copies for their internal records. By default leave permissions to read-only, until requested otherwise. It’s not uncommon to allow download access for investors that have presented you a term sheet.

How to choose the right VDR solution for early stage venture deals

If you’re a founder on a budget, there’s nothing wrong with using Google Drive as your VDR. It’s familiar, easy enough to use, and relatively cost effective but there are some downsides to using Google Drive. Google Drive wasn’t purpose built to be used as a VDR so it’s not going to have a lot of the robust features like MFA, encryption, watermarks, and robust levels of permissions.

Here’s a few things to consider when choosing a VDR:

If you’re looking for a great early stage option that’s built specifically for early stage venture deals, checkout Data Room Link. We built Data Room Link specifically for early stage founders seeking venture investment. It’s lightweight, easy to set up, and has all the features you need to build a stage 1 and stage 2 data room. Data Room Links is free to get started and you can use code: OPENVC to get 20% off any paid plans.

Investor Red Flags in Data Rooms for Startups

When preparing a data room for investors, certain red flags could raise questions and potentially affect their confidence. Here’s a list of areas to review closely to avoid unnecessary skepticism:

1. Incomplete Financial Records

2. Unclear Cap Table

3. Lack of Documented IP Ownership

4. Legal Liabilities or Pending Litigations

5. Inconsistent Business Metrics

Summary

In conclusion, a data room is a crucial aspect of early stage venture deals for both founders and investors. With the rise of virtual and online data rooms, it has become easier to create and manage these spaces. The role of data rooms is to provide a centralized location for important documents and information during the deal-making process. For early stage venture deals, there are two stages of data rooms: stage 1, used before receiving a term sheet, and stage 2, used to streamline the due diligence process. By understanding how to structure and choose the right virtual data room solution, founders and investors can ensure a smooth and successful deal.

About the author

John Ladaga is a multi-time founder originally from Atlanta, Georgia. He now calls Denver, Colorado home and enjoys skiing and hiking in his free time. In mid 2021 John and his co-founder Filippo launched Sturppy.com, a SaaS platform that helps founders build, manage and share investor-ready financial models.

Supported by a fully remote team, the pair have grown Sturppy to over 4,000 customers in 96 countries over the past 18 months. Most recently John and Filippo launched Dataroomlink.com, a virtual data room solution specifically built for early stage founders navigating venture deals.

If you’d like to connect with John, he’s active on LinkedIn and on Twitter.