Fundamental Concepts of Data Rooms for Startup Companies: Stage 1 Information for Term Sheet

Following a successful pitch session and subsequent discussions with venture capitalists (VCs) or potential investors, the need for more data or access to your data room might arise. 

Investors are seeking to validate the details presented in your pitch deck and obtain a deeper understanding of your company’s various aspects, including its business model, progress, and financials. 

Rather than sharing cumbersome Excel spreadsheets internally, a data room proves more efficient for managing these extensive datasets.

Essential Points about Data Rooms

A secure and controlled environment is crucial for your data room, accessible only to designated individuals. Early-stage businesses often opt for cost-effective cloud-based solutions such as Google Drive. Moreover, it might be wise to keep track of usage, identifying who accesses the data and which datasets receive the most attention. 

Numerous vendors provide virtual data room solutions for companies handling substantial data quantities and requiring enhanced controls.

The process of constructing your data room should commence during the pitch phase. While some information is readily available, certain elements may require additional time as they must be gathered from legal sources and other team members. 

Proper organization and continuous updates are essential for maintaining an adequate data room.

Stages of Data in the Data Room

Each VC may have a slightly different process. Data requests arise at various points during deal flow discussions, with two specific stages being the most common.

• Stage 1: This phase focuses on data essential for investors to draft a term sheet. It predominantly includes details such as your product-market fit, financial models, and capitalization table. It might also encompass aspects from Stage 2 but in less extensive detail, such as bios of key team members.

• Stage 2: Detailed due diligence data is sought after a term sheet is received. This entails comprehensive information about company documents, securities-related documents, significant agreements, financials, and personnel.

Sharing additional data and granting data room access should occur upon investor request. Offering premature access to the data room is unlikely to prompt further interest in progressing to a term sheet.

Contents of Stage 1 Data Room: Key Information to Include

Stage 1 data is crucial for investors to create an investment memo for internal decision-making and to generate a term sheet—an initial financing proposal outlining economic and control terms. Here’s a closer look at the pre-requisite you should provide:

Product-Market Fit

Investors have already validated the level of your PMF in the second half of your pitch deck, more likely during your pitch. At this stage, they are looking for metrics and tangible evidence.

Evidence of a substantial and reachable target market can be demonstrated through data, incorporating customer insights, DAU, MAU, sales, members, LTV, CAC, CTR, .. or other metrics that make sense for your business model.

Additionally, you can leverage authoritative industry reports from renowned firms like Gartner, Deloitte, and McKinsey to underpin your narrative effectively. Although many investors look for TAM, SAM, and SOM, these metrics are only helpful for later-stage startup investments.

Moreover, showcasing your solution’s relevance to a genuine issue involves presenting customer data that validates your value proposition and pricing structure. This entails information such as:

• Metrics on customer acquisition and retention
• Levels of customer engagement, exemplifying their product usage frequency and preferred functionalities
• Demonstrating customer Return on Investment (ROI), particularly applicable to Business-to-Business (B2B) ventures
• Tracking and analyzing cohort data over time
• Establishing a competitive stance in the market

Financials

The VC or investor is interested in several aspects of your financial history, including profit and loss records, balance sheets, past grants received, and comparable valuations. However, their primary focus centers around these pivotal factors:

• Gross profit margins
• Trajectory of monthly recurring revenue (MRR)
• Cost of customer acquisition (CAC)
• Quantification of long-term customer value (LTV)
• Sales pipeline visibility and forecasts
• Intended allocation of raised funds
• Validation of your business model through significant client contracts or partnerships

For example, in our Financial DD we search for capital efficiency; not everyone is interested in that, but we are, and many other investors look for it, especially in these times.

Many investors will be happy with your bank statements, which sometimes makes it easier on the founders’ side.
It’s crucial to present your data with transparency. For instance, it’s essential to differentiate between overall revenue and MRR, with the former possibly encompassing sporadic consulting income not directly tied to your core product and therefore not reproducible.
To avoid potential concerns, minimize or provide comprehensive explanations for any dealings involving companies managed by the same founders, intercompany assets, or intellectual property ownership.essential

Emphasize any funding or support obtained through non-dilutive means, such as winning pitch competitions or securing grants from provincial and federal entities. This further substantiates your business and enhances your reputation as a resourceful and determined company. Each case is unique.

For example, especially because of the trends in recent years, for a deep tech startup in the US, it is essential to have some non-dilutive capital, for example from National Science Foundation research grants. It’s a form of validation and credibility.

Company Documents and Cap Table

Efforts should be directed towards cultivating a well-organized cap table in the lead-up to fundraising to reduce potential objections from VCs or investors. 

For instance, consider buying out a co-founder who might have disengaged and distanced themselves, ensuring uniform terms for prior investors, and minimizing the number of angel rounds executed on straightforward agreements for future equity before a substantial VC round. 

To provide a clear perspective on both current and future ownership structures, it’s advisable to incorporate the following elements:

• Official articles of incorporation
• Comprehensive biographies of co-founders and profiles of other invested individuals
• A transparent depiction of the share options pool
• Thorough documentation of terms and clauses that could influence future scenarios, such as liquidation preferences outlined in previous term sheets that might impact incoming investors.

Investors and VCs prefer co-founders with a substantial financial stake in the enterprise, demonstrating their firm commitment. Any inclination of early-stage founders to relinquish a notable percentage of ownership might raise concerns.

Product Roadmap and Competitive Positioning

To effectively showcase the value and distinctiveness of your product within the market, incorporate the following data:

• Provide a link to a product demonstration (if you can).
• Present details about your intellectual property holdings, including patents and trademarks.
• Include analyst reports that substantiate and affirm the merits of your product.

Staff

Founders and co-founders typically need to demonstrate an unwavering dedication to their startup as their sole business endeavor—indicating that their focus is solely on this venture—before pursuing funding from VCs or angel investors. 

If this isn’t the circumstance, it’s imperative to offer investors a compelling rationale for their involvement in other ventures, along with a well-structured strategy outlining the transition to full-time commitment, which serves as a testament to their strong commitment.

Within your repository of information, make sure to provide comprehensive insights into the following:

• Profiles of founders highlighting their individual accomplishments, as well as collaborative achievements, past companies, and roles. Unlike the pitch deck, here you have more room for information.
• Biographies of advisors and key members of the executive team, shedding light on their expertise and contributions

For example, for your key members or co-founders, you want to make sure you highlight the “Notable Contribution” in this field. If it is the CEO, CFO, or CTO, if you have any, you want to highlight “Prior Successes” with other startups or specific products. Here, you have the room to create a narrative for your great team.

If you have an early investor, use it here, and reserve a section (if they have it) on “Prior Key Investments”, for example, creating a narrative about the ability of this investor to discover hidden gems in the market.

Each aspect, section, and paragraph of your documents must be clear and persuasive. We discuss extensively all these aspects in the Founders Cohorts program.

What not to share in your data room

Caution is advised against sharing proprietary information, trade secrets, or code within your data room, including high-value sales prospects.

By adhering to these guidelines, startups can effectively manage their data room, present themselves transparently to potential investors, and navigate the intricate process of securing funding.