complicated concepts

Why Data Rooms Are Important

My colleague Kera (who runs the behind-the-scenes ops of this newsletter) was recently considering investing in a new startup.

As part of the due diligence process, the founders sent her their data room.

Kera is new to investing, so she had no idea what to expect.

So she did what anyone would do – she procrastinated.

It wasn’t until she talked to Elizabeth Yin (co-founder of Hustle Fund) that she realized what a data room actually was.

Elizabeth shared that, when it comes to data rooms, the data itself is not the important piece. There’s something else that Elizabeth looks at when she views data rooms.

Let me explain what went down.

But first, what is a data room?

A data room is a place where founders store their most important company documents, like:

  • Incorporation docs
  • Bylaws
  • Cap table

Basically, data rooms show that this is a legit company with actual employees.

Super early stage startups don’t need a data room. But we’ve met great pre-seed and seed stage startups that have a simple Dropbox or Google Drive folder with their key documents.

For series-A and beyond, data rooms are important because they have a lot more documents, like:

  • Financial projections
  • Client contracts
  • Board minutes
  • Founder stock purchase agreements
  • Option plan and stock option agreements
  • 409A valuation report
  • Cap table

Founders usually send prospective investors a link to their cap table.

But do we actually need to look at all the documents?

Well… yes and no

When Elizabeth personally invests in startups, she doesn’t ask to see their data room.

Now, she does ask for their incorporation papers to verify her investment is going to the company, not the founder’s bank account.

But if the company sends her a link to the data room anyway, she doesn’t thoroughly review each document.

She wants to see how the founders organize their data room.

There’s a famous quote:

“How you do anything is how you do everything.”

See, as an investor you can expect that the way founders keep track of their documents is reflective of the way they run their companies.

Impressive companies have everything organized, easy to find

  • All documents are filed in the correct folders
  • All important documents are included
  • Everything is clearly labeled and easily searchable

Messy companies, well, have very little sorted out

  • Nothing is organized
  • Files are missing
  • Documents aren’t properly labeled

Sure, you should look into some of their documentation. But what is more important is how they set up their Dropbox folder.

Because how you do anything is how you do everything.

What if a founder doesn’t have a data room?

In the early days, not having a data room isn’t a big deal. But as a company matures, there are consequences for not having one.

For example, we know a founder whose fundraising round stalled for months because his data room was missing half of the required documents.

As a best practice, we send all companies we invest in a checklist of items to share with us before we wire them money.

Some of these, like a 409A doc or cap table, may be overkill… but the fundamentals are there. Any startup lawyer can easily provide this to a company.

So the next time a founder sends their data room to Kera, she’s surprisingly excited to dig in and see how they set everything up.

What a nerd! 🤓

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