“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.
Table of Contents
What is a data room?
The term originated from the M&A space in the 19th century, before the prevalence of modern day computing. When a company was undergoing the process of being acquired, M&A teams would create a physical room filled with filing cabinets containing sensitive company documents and information on paper. The rooms were often physically guarded with strict security protocols (no photos, no photocopies, only accessible through appointment under supervision, etc.).
The creation of data rooms was a game changer for the M&A world but creating and maintaining physical spaces came with its own difficulties and risks. They were expensive, clumsy to navigate, and god forbid a sleep-deprived M&A analyst ashes his cigarette in such a way that he sets the last 10 years of financial statements a blaze!
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.
How to structure a stage 1 data room: What information should you include?
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:
- Business Summary / Company Overview
- Purpose: provide an overview of the problem your solving, your solution, and competitors - make it easy for the investor to create a deal memo
- Docs to include:
- 1-page business overview
- Links to your company website and social platforms
- PDF copy of your current pitch deck
- Traction / Product Market Fit
- Purpose: provide data that proves you’re solving a real problem - better yet with a solution to a problem that a lot of people have and are willing to pay meaningful dollars for
- Docs to include:
- Market sizing - bottom-up or top-down TAM backed by relevant up-to-date data from reputable sources
- Customer / User data - how many customers or users do you currently have, how engaged are they
- Competitive positioning / Unique Selling Proposition (USP)
- Customer acquisition data - CAC, CAC payback
- Financials
- Purpose: provide a financial overview of your business from the day you started to present day with forward facing projections. If you don’t have a financial model built, I highly recommend you checkout Sturppy. Sturppy’s used by 4,000+ startups and allows founders to build an investor-ready financial model without being an expert on finance or financial modeling.
- Docs to include:
- P&L / Income Statement
- Balance Sheet
- Cashflow Statement
- Financial Projections 1-3 years in the future
- Team & Roles
- Purpose: provide an overview of your team, their experience, and the roles they play in your business
- Docs to include:
- Doc containing brief profiles on each team member, their role, their prior work experience, their time with the company, and links to their social channels (LinkedIn)
- Cap Table
- Purpose: provide an overview of who owns equity in the business today.
- Docs to include:
- Cap table summary
Done right, your stage 1 data room should be simple, clean and look something like this:
Sharing your stage 1 data room: When, who, & how?
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: What information should you include?
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:
- Entity Formation Documents
- Purpose: These documents are mostly needed by the legal team and are the set of documents used to certify your business’s good standings. These docs are going to fluctuate based on where your business is incorporated and the type of business entity you’ve chosen. If you’re a startup in the US, 9/10 if you’re raising venture, you’re going to be established as a Delaware C-Corp
- Docs to include:
- Shareholder certificate documents
- Local/state/federal business licenses / letters of good standing
- Articles of incorporation
- Bylaws
- Tax ID number
- Operating agreement between founders
- Shareholder meeting minutes / board minutes
- Annual meeting notes / minutes
- Customer & Partner Contracts
- Purpose: Material agreements will vary form company to company based on the nature of business but the general gist is to include anything that could significantly impact the business
- Docs to include:
- Standard terms of service or use between your business and customers
- Any agreements or understandings between your company and others with obligations exceeding $25K
- Property leases (real estate and personal)
- Licenses of any company IP to 3rd parties
- Any agreements outside the ordinary course of business that could have a material impact on the business
- Any licenses and permits needed for operating legally within your industry
- Proof of Intellectual Property
- Purpose: If your company has IP and that was part of the pitch, you’re going to have to show proof of that IP. This includes patents, trademarks, copyright, design
- Docs to include:
- Evidence that you have the right to the IP that you’re developing
- Patent information (proof of filing / issuing)
- Trademark registrations
- Copyrights
- Full cap table documents
- Purpose: If you’ve followed this guide, you’ve already shared a summary of your cap table. At stage 2 you’ll likely need to divulge additional details such as:
- Docs to include:
- Details of previous fundraising rounds or liquidity events
- Shareholder certificates
- Vesting schedules
- ESOP details
- Tax Filings
- Purpose: Proof that your company is in good standings with the IRS
- Docs to include:
- Tax history
- Previous filings
- Previous audit statements and any third-party financial evaluations
- Information on Any Outstanding Litigation
- Purpose: This one is key…failure to divulge pending or outstanding litigation can and will likely result in a very bad outcome for you and your business. Be honest here, have the hard conversation with the investor at this stage in the process.
Sharing your stage 2 data room: When, who, & how?
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: vendor selection criteria
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:
- Security and privacy: The VDR solution should have robust security features such as two-factor authentication, access controls, and watermarking capabilities
- Ease of use: The VDR should be easy to navigate and use for both founders and investors alike. It should also be easy to create folder structures that are easy to understand and set up.
- File sharing and collaboration: The VDR should allow for easy file sharing and collaboration among parties involved in the deal.
- Analytics and audit tracking: The VDR should have built in analytics that allow founders to know who accessed X, who downloaded Y, and when they performed those activities.
- Storage scalability: VDR solutions should be scalable and have sufficient storage capacity to house all of your documents
- Price: Early stage deals are relatively simple in nature. If you google “VDR solutions” you’ll likely come across a lot of solutions that aren’t really made for conducting early stage venture deals - most solutions like DealRoom and iDeals are more so built for M&A and larger deals. They’re expensive and frankly overkill at this stage.
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.
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
