Data room basics for startups: Stage 2 data for investor due diligence

Setting up your data room? See Data room basics for startups: Stage 1 data for the term sheet.

You have just been offered a term sheet from an investor or a VC. Congratulations! To finalize the funding, they would like to commence due diligence and then move toward contract finalization. The detailed stage 2 data in your data room is critical for this due diligence exercise and provides the following:

• Additional information on existing areas of your business (e.g., financials) that have been reviewed in stage 1. The expectation is that the investor should be even more excited with this level of additional detail.
• Information on new areas—this covers areas of your operations that have not been reviewed earlier (e.g., material contracts) in order to ensure there are no red flags.

Data room basics 

Note: For information on setting up your data room, please see Data room basics for startups: Stage 1 data for the term sheet.

In some cases, what is generally seen as stage 2 data may have been specifically requested by the VC pre-term sheet—in which case, it’s already in your data room.

To organize your data for stage 2, you can add data files or subfolders to existing folios you have created in your data room (e.g., “Financials”). For the new areas, it’s best to create new folders (e.g., “Material contracts”).

Use the sections below as a structure to help organize your data room folders.

Stage 2 data room content: What information do you need to include?

For stage 2, you need to include additional data in the existing areas covered broadly in stage 1.

Products, sales & marketing

This includes additional documents the investor would like to see, which would generally substantiate your pitch with more detail.

• Product roadmaps: Greater detail and long-term vision on what this product can become
• Marketing strategy documents
• Direct sales and channel strategy
• Sales pipeline data and conversions (particularly important for B2B and enterprise ventures)
• Pricing strategy and history

Financials

Most of the financials are covered off in stage 1. There are additional areas that are normally requested to confirm financial robustness and ensure there are no surprises from the earlier pre-term sheet reviews. These include:

• Documentation to support key balance sheet and financial statement items, such as loans, mortgages, government grants and leases
• Insurance policies and coverage details, and proof of payments

Company documents and cap table

This is a focus area, mostly to check that there are no red flags from the earlier reviews. Some of the additional data that should be provided includes:

• Organization structure and charts, including all subsidiary details
• Board of director materials, such as meeting minutes and board consents
• Securities details, including shareholder and option holder details and agreements, voting rights and vesting schedules

Staff

This is a deeper dive to give the investor confidence that you have a robust team with clearly documented financial payouts and legal mitigants. It’s critically important that this data is updated on a regular basis. Some documents typically requested include:

• All employee contracts or employment letters, with full details on compensation structure; and documentation on adequate provisions of non-compete, non-solicit and non-disclosure agreements (NDAs), if separately captured
• Independent contractor agreements and NDAs
• Deferred compensation letters and change of control provisions
• Standard terms and conditions of employment, including grievance procedure handling
• Employee policy manual and handbook (if available)

New areas to add to your data room in stage 2

In addition to these areas above, which have been partially seen in stage 1, there are new areas that have not been provided in the pre-term sheet data discussions. While these may seem simple, they can make or break the deal.

Intellectual property

For most software companies, patents are rare. Having said that, a venture may have multiple areas of IP, and the investor will want to validate that there is a reasonable legal moat to keep competition away. Here is what you should have in your data room:

• All owned and granted patents, as well as patent applications
• All owned trademarks, service marks and material unregistered trademarks
• All owned domain names, as well as confirmation by the registration authority that they are owned by the venture
• Third-party IP documentation to support usage of any such IP

Privacy policies

This is an area more relevant to ventures offering services or goods to individual customers (as opposed to business customers). Inadequate policies and compliance can sink a company. Make sure you provide:

• Relevant state and country privacy policies that apply to the information your company has on individuals
• Internal policies on how this information can be used and compliance check records
• Jurisdictions in which your company collects, stores and uses personal information

Material contracts

Typically, contracts exceeding a specific financial value (normally $5,000) or with key partners need to be shared with an investor. Carefully thought-out contracts with strong provisions create a robust base for the startup to grow on, and it’s best for you to engage good legal talent for all material agreements to prevent any inadvertent gaps.

The documents you need to provide include:

• Standard customer terms and agreements
• Channel partner, franchise and consulting agreements
• Technology sharing or licensing agreements

Litigation & liability

Investors review these areas to be certain that there are no known legal or financial exposures that can affect their decision to proceed with a deal.

• Documentation on all pending or threatened litigation, actions or regulatory matters that may affect the company. The source could be disputes with staff, competitors or customers. It could also include any government agency interactions, or regulatory issues or disputes (such as those with federal tax authorities or financial regulators such as the Office of the Superintendent of Financial Institutions).
• In addition, the investor may want to see any provisions that have been made in the company financials as a consequence of any such case.

Information technology

This section includes documentation that provides clarity on your company’s software products and their functionality, in addition to the range and legality of any third-party software used.

• Documentation to better demonstrate software capabilities:
  • System architecture and infrastructure details
  • Product design documents
  • API documentation
  • Data security and penetration test details

• List of software offered to customers
• List of third-party and open-source software used in the creation of software products, as well as copies of the agreements allowing the use of this software