Raising capital is an exhausting process. A founder of an early-stage company, especially an early-stage climate tech company, is much more likely to hear a “no” than a “yes” from investors.
In between a no and yes is a maybe, which is what founders often hear from investors during the capital raising process. And when you receive that “maybe,” it is usually followed by one simple question:
“Can I see your data room?”
What is a data room? It is the collection of all documents relevant to an investor for underwriting your business for an investment.
The question’s simplicity should not overshadow the importance of the answer, which should be a resounding and straightforward “Yes!” because we will assume you are talking to a legitimate investor with whom you are comfortable, which should be the prerequisite to any “yes.”
The last thing you want to do is have an investor interested in your company and not have a data room ready to share. The only thing worse than not having a data room ready is having a data room that gives investors doubts about investing in your business. Having an organized, established data room ready to roll before starting the investment process is critical to a successful raise. Let’s examine what goes into building the perfect data room.
Your data room is a digital warehouse that will hold all the critical records and documents that investors will need and want to see to complete their diligence process and finalize their investment in your business, which sounds a lot like the document management system (DMS) that your team uses to manage all the company’s records.
They may sound similar, but your data room and your DMS are two separate things. First, not every document in your DMS should be in your data room. Second, to avoid confusion and enhance security, your data room provider should be different than your DMS provider.
Often in the early days of startups, your DMS provider is simply Google Drive or Microsoft OneDrive. Whether those are the right choices for your DMS is the topic of another blog post.
If you have chosen one of those, then make your data room something different. There’s no need to run off to RR Donnelley or IntraLinks and sign up for a data room (although you may want to do that if you’re doing a crossover round or preparing for a sale or public offering). What you simply need to do is find a reputable, secure, cloud-based storage solution that is different from your DMS.
If you use Google Drive for your DMS, then pick Box. Or, if you already use Box, choose Dropbox for your data room.
Reputable, safe, secure, and different from your DMS. You get the point!
Now that you have your data room provider selected, you’ll need to ask yourself whether you will require a signed non-disclosure agreement (NDA) to gain access to it.
This is a tricky question. The natural inclination is to have folks sign an NDA, but investors often hesitate to sign NDAs. They don’t like them and don’t want to be bound by them. You must weigh the costs and benefits of what you’re protecting versus driving more investors to your data room.
Sometimes, critical pieces of intellectual property, customer information, or company information will absolutely require an NDA. A lawyer will probably reinforce this with a recommendation. Take their advice. And if you do need an NDA, ensure you have a straightforward, clear form ready to go so the signing process is as efficient as possible.
Now that you have your data room provider selected and your NDA question sorted out, it’s time to outline the structure of your data room!
The structure should tell a story. I’m not asking you to write a Dickens classic, but I am suggesting you organize it to take the potential investor through your business in a clear and convincing way.
Start with a “Capitalization” folder describing the capital you’ve previously received. Move to a “Corporate Governance” folder highlighting the board’s work before the “Admin” folder with key information like leases, insurance policies, employee handbooks, and benefits. Then, you head to the core of your business with an “IP” folder containing information on how you are protecting your intellectual property, a “Marketing” folder that showcases key brand elements and resources, a “Sales” folder that shows customer leads and any existing contracts, and an “Operations” folder that shares relevant manufacturing or piloting information. End with your “Finance” folder, if you haven’t displayed this folder earlier, in which you will keep forecasts, actuals, and those marvelous reviewed or audited financial statements.
In sum, you’ll have a structure that looks like this:
This structure isn’t the only one you can use, but it does tell a comprehensive and compelling story that shows an investor you are doing more than just developing a technology; you are building an enduring business!
With the created structure, you’ll need to fill the data room. Too few documents in a data room could make a diligence team nervous. Too many documents in a data room and an investor could become overwhelmed or mired in diligence.
You’ve got to find the right balance and create the Goldilocks Data Room, ensuring each folder has the relevant, required, and correct number of documents.
Take the Capitalization folder, for example. Don’t just throw your cap table in there; have your cap table, a stock ledger or summary of all cash into the business, a summary of your stock option pool, and the relevant documents to the issuance of stock, such as the charter and stockholder’s agreement. Those last two documents may appear in your Corporate Governance folder, too, and that is okay. One of your jobs here is to make it easy for the investor to learn about your business.
A few other points worth mentioning about your data room:
Your data room is complete, and you’re sharing it with investors. Excellent! There’s just one more thing; you need to know what’s in it.
This may seem like a silly point, but it is critically important for three reasons. First, as I mentioned, investors don’t know all the intricacies of your business. They are learning, so you must be prepared to answer many questions about the types of documents in your data room and what those documents say about the business.
Second, as you work towards closing, you and your counsel will negotiate a stock purchase agreement (assuming this is a priced round) with your investors and their counsel. In that stock purchase agreement, there will be several representations and warranties that you will make and a corresponding disclosure schedule that will be attached to the stock purchase agreement. These representations will require you to disclose leases, deviations to a standard form of stock option agreements, major contracts signed with vendors, the accuracy of financial statements, and much more. For every disclosure you make, you’ll want to ensure there is a corresponding document in the data room.
For example, if in the stock purchase agreement, you represent and warrant that the company has no real estate except for what is listed in the disclosure statement and the disclosure statement lists a three-year lease on office space, then make sure that lease is in the data room.
It all seems simple, but it is incredible how the complexities of a data room can either expedite or slow down the diligence and closing process. As we’ve said before in our financial controls post, a great data room isn’t going to be the reason why someone invests, but it could very well be a reason why someone doesn’t invest or takes longer and spends more legal fees getting to the closing.
Third, speaking of those legal fees, the legal fees for closing a new investment can be a lot! Do not underestimate them, and be mindful of what you will spend and what you may have to reimburse investors (it is common for investors to ask for reimbursement of their legal fees) as part of closing.
Building a great data room and knowing what’s in it will undoubtedly save you time and money when closing your investment round. Do yourself a favor and create that Goldilocks Data Room. You, your current and future investors, will be better off for it!
