From late 2020 to early 2022, many investors rushed to hand out term sheets after seeing little more than a pitch deck.
Now, the metaphorical hangover is setting in—VCs are paying more attention to company quality and pushing past what Laura Lenz, a partner at OMERS Ventures, called “ego-raising.” An investor for over 20 years, Lenz has prioritized in-depth diligence for companies regardless of economic cycle. And in her experience, one of the best ways a startup can stand out in the fundraising process is with a high-quality data room.
Speaking with BetaKit, Lenz explained the significance of a well-crafted data room and offered her three-step process for building one.
Be ready to answer any question
Investors want to know as much as possible about the business so they can make an informed decision. That’s where a data room comes in.
“SaaS companies, operating in an environment defined by rapid change and fierce competition, need to make real-time insights easily accessible to adapt swiftly and serve their customers effectively.”
“It’s a repository for all the company’s information that’s secured [and] shared to the appropriate people at the appropriate time with admin provisions,” said Lenz.
While this might sound like just a very secure version of a digital file folder, it’s incredibly important in the fundraising process.
“The purpose of a data room is to answer any questions that an investor or advisor has,” Lenz added.
Lenz said it’s not uncommon for VCs to look at historical financials, forecasts, product usage and retention data, roadmap, competitive landscape, sales pipelines, IP ownership, and cap table composition before even thinking about making an investment decision. The reasoning behind such a broad range of information is that VCs never know which insight might prove to be a golden ticket (in the form of a significant, previously unknown advantage) or a major issue that could kill the company if not addressed.
Eric Sleeth, Senior Industry Marketing Manager at Sage, said data is the “single source of mistrust” in organizations, noting he sees “too many SaaS companies trying to make business critical decisions with spreadsheets with snapshot-in-time data that can be broken with one tweak to an equation.”
“SaaS companies, operating in an environment defined by rapid change and fierce competition, need to make real-time insights easily accessible to adapt swiftly and serve their customers effectively,” Lenz added.
To illustrate, Lenz shared a hypothetical example of a startup where the entire management team only owns 3 percent of the company after dilutive earlier rounds. If that was the only stat she knew about the company, Lenz said she’d likely pass on investing because the equity is not significant enough to motivate leadership. However, if she had access to a full data room that showed amazing potential for company growth, she might put a condition of investment that other investors are diluted and the option sheet is re-upped to provide more motivation for management.
“We need to know that information before we proceed with the term sheet,” said Lenz.
Building a great data room
Building a great data room starts with collating information, which can be challenging since data might be manually documented in a spreadsheet or tucked away in one of the dozens of SaaS platforms a startup might use. The second difficulty is updating the room every time something new happens: for instance, adding quarterly financials or uploading an employee contract with each new hire.
But that doesn’t mean it can’t be done well, and Lenz’s advice for building a great data room can be broken down into three steps: security, monitoring, and tiering. Security starts with the right tools to control permissions and access, both internally and externally.
“The problem is the mismatch between the need for visibility and relying on old tools that require manual consolidation of data sources and maintenance,” added Sleeth. “Real-time dashboards with the ability to drill down would set a SaaS company apart by fostering trust, transparency, and confidence to assess performance trends, identify potential risks, and uncover growth opportunities.”
From there, monitoring who is using the room (and what documents they view) is the secret weapon that Lenz said startups need to take better advantage of. For example, if you upload a new document and a VC downloads it immediately, that’s a strong signal they are interested. Or if an investor hasn’t accessed the data room in a month, you can safely remove them without notification—if they want to access files again, they can ask.
“A strong head of finance would monitor which funds are actually in the data room and which ones they should cut off if there’s no activity,” said Lenz.
Tiering means organizing data into different access levels based on how interested and in-depth your conversations are. Tier one contains data that, theoretically, you wouldn’t mind sharing with every potential investor: a pitch deck, last year’s financials, a three-year year forecast, competitive landscape, and market reports.
“You shouldn’t worry about it being shared because it’s mostly all out there,” said Lenz.
In tier two, only put data that a VC might need to conduct initial diligence before a term sheet: high-level usage data, revenue and pipeline numbers (without customer names), a high-level product roadmap, and general cap table information. Tier three is only for post-term sheet due diligence: legal files such as employee lists, stock option valuations, incorporation docs, previous financing rounds, board minutes, and IP ownership information.
Lenz said by tier three, “you’re now in exclusivity; you’re only working with one partner fund. You’re hoping that this fund financing is going to close.”
More than document management
Building a high-quality data room is crucial for the information it provides. When Lenz is interested in a company and wants to know more, a data room makes it easy to find the information, which helps build deal momentum. But more than that, it’s also a signal that Lenz said shows a company is willing and able to get all their documentation together and is ready for the reality of fundraising; in short, they appear more mature.
“It presents an image of a company,” said Lenz. “It enables a company to demonstrate to an investor that they are thoughtful, that they’re thorough, that they’re accurate, versus incomplete, sloppy, or worse—withholding something.”
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