‘The auditors are coming next week’.
It was always one of the biggest times of the year for many companies; the day when a group of auditors would arrive in the building, take up a space, and then diligently go through file after file of financial documents for several days. The company accountants would carry pieces of paper back and forth, and the doors would be locked at lunch.
This physical presence of the auditors was a necessity. They simply couldn’t do their job without being there, and this was also once true of the venture capital due diligence in a merger or acquisition.
That is no longer the case. Nowadays, we use a data room.
A data room is the modern, virtual, equivalent of a locked room full of auditors except that it is stored in the cloud. It securely stores those important documents and files needed for an investment to go through and provides a one-stop-shop for all parties to access and request information.
But what documents does a data room contain, exactly? How do you build one? And why is it so important in the due diligence process?
What documents does a data room contain?
A data room does not contain every detail of your business. In fact, we should say at the outset that it’s important to be strict with yourself on what you want to put in a virtual data room. A messy, hard-to-follow data room can be counter-productive and put off VC investors.
We’ve broken down what you need in a data room into legal, financial, historical, vision, HR, and asset documents.
- Legal Documents
At its most fundamental level, your data room should contain all the legal documents about the structure of your company and articles of incorporation.
- Financial Documents
Financial documents are another fundamental part of a data room. Previous audits, tax records, any financial evaluations from external providers, profit and loss statements, cash flow projections and more, are the documents that provide the figures behind your business.
- Historical Documents
Next, you have to provide the facts behind those figures. You should include minutes from Board meetings, records of major past decisions, and everything an investor ought to know before committing to you.
- Vision Documents
You’ll also need those documents that describe the future of the company and how you got where you are. General business plans, overall pitch deck, marketing plans, sales strategies, product demo videos, current sales figures… all those documents that explain to potential investors where your company is heading (or, at least, trying to get to).
- HR Documents
Investors will want to know your people. From basic information like contracts and any equity they have (or have been offered) to more qualitative information like future HR plans, investors need to be given a clear overview of what’s happening in your workforce.
- Asset Documents
What assets does your company own? From intellectual property, patents and trademarks on the product side, to capital assets like property (whether owned or leased) and machinery, any investor will want to know the detailed breakdown of any assets you own, their depreciation rates, and any future investments they’ll require.
- Your Cap Table
This will probably be the first thing investors look for and examine in detail. Your cap table contains details of who owns your company, how much of the company do they own, and previous fundraising events. An unclear or inaccurate cap table can be an insurmountable obstacle for many deals.
Due Diligence Data Room Checklist
Here’s a simple checklist of the documents your due diligence data room may contain:
- Articles of incorporation and legal documents
- Records of ownership – often in the form of a Cap Table
- Shareholder certificates
- Previous funding round records and liquidity events
- A comprehensive record of company financials and future projections
- Product and/or service information, from historical prototypes to future roadmaps
- Future business plans, including marketing strategies etc.
- Current sales strategy and pipeline, including existing customers MRR (Monthly Recurring Revenue) and ARR (Annual Recurring Revenue)
- Tax history, previous audit statements and any third-party financial evaluations
- Any significant third-party agreements and partnerships
- Documentation of any capital assets the company holds, including long-term leases etc.
- Any intellectual assets such as IP, patents, trademarks and ongoing R&D investments.
- An overview of the key team, including employment contracts
- Any licenses and permits needed for operating legally, as well as official correspondence with any regulators relevant to the business.
- Minutes from previous board meetings
- Your business continuity plan
- Your pitch deck
This is not a comprehensive list, however. As with all deals, there will be unique circumstances and investor requests outside the usual scope.
The purpose of a data room is to have a clear company record for the purposes of a due diligence process – VCs and investors are looking for concise data on which to make a major decision. Be wary of too much information though, as it can be just as bad as having too much in it. Your data room should answer questions, not raise more.
Even as early as the seed stage, an organized data room can make you stand out from the crowd.
Sharing a list below of items that I received this week from a founder who is ~2 months away from raising. Left me so impressed and eager to move fast on the deal
— Andrea Funsten (@AndreaFunsten) July 9, 2020
How do you build a data room?
A data room is simply cloud storage, so you can build a data room that’s either simple or add layers of functionality. Of course, you can always just buy space on the cloud and pile data into it, but there are providers out there specifically focused on data rooms for businesses.
These providers will give you access to templates, allow you to manage and sort your files easier, give multiple people easy access and converse with each other (much like those auditors and accountants), allow for analytics and tracking, and provide a secure environment from cyber threats.
In many ways, what you are doing by contracting one of these providers is professionalizing your data to impress potential investors. The information won’t be different, but it’ll be easier to ‘sell’.
The following are a couple of the leading providers of data room storage out there:
Why is a data room important in the venture capital due diligence process?
It could be easy to dismiss a data room as just a place to store documents, but in reality, it can make or break a fundraising round. A bad data room (or none at all) will inevitably slow the process down at the very minimum, and potentially cause an early loss of trust between investor and owner.
An investor that finds an organised and comprehensive data room will tend to look at the business (and its owners) more favourably. It’s the equivalent of walking into a house for sale and the walls are painted, the grass in the garden is cut and there’s a smell of fresh-baked bread. It makes the buyer feel there won’t be any hidden surprises.
An interactive data room can bring that to another level, adding value to the process through ease of communication and analysis for both sides.
At the same time, if you’ve clearly got the next multi-billion-dollar idea then a good or bad data room won’t stop those investors banging down your door. But, even then, the data room can have real power in ensuring the deal you strike is advantageous to you. It’s easy to cash a cheque and only realise the consequences later.
If you’re a company on the path to growth and looking for funding, a data room may well be worth the investment. Then, when the ‘auditors’ come, you’ll have the answers to hand.
Talk to our experts today and see how we can support you in making your data room a great experience for investors.