The Anatomy of the Data Room - by Morgan Cheatham

Hey! I’m Morgan and I’m a Vice President with Bessemer Venture Partners investing in healthcare and life sciences. I’m also in medical school. This newsletter is an evolving collection of what I’m learning as I translate between the worlds of venture capital, technology, and biomedicine. You can subscribe for free to follow my journey:

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Over the last five years of my investing career, which has now spanned both bull and bear markets, one thing has become very clear: preparing companies for fundraising is an extremely time-intensive exercise for founders, company leaders, and investors. Though the onus of raising largely falls on the CEO and their leadership teams, investors can play a key role in developing the strategy, making introductions to prospective investors, and “working the cap table” — the practice of speaking with existing and prospective investors to influence the process.

Fundraising is far more an art than a science, and though external market factors can inform many aspects of the process such as speed, valuation, round size, and more, underpinning most (and hopefully, every) strong fundraising process is a compelling narrative supported by strong data.

In this piece, I’ll discuss how to build an effective data room that supports an efficient financing process in any market environment.

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This post intentionally spares readers of my armchair macroeconomic view because in reality, great companies are built in all markets, and therefore, great companies have to raise in all markets (though perhaps the greatest companies don’t have to raise at all because they’re profitable).

So what is a data room you might ask? The first time I heard this term, I was working as an investment banking intern at Goldman Sachs and someone told me to “take a spin through the data room.” Interesting. Where was this mystical data room? It sounded fancy. Would we visit the data room in person? Is this where board meetings were held? Enter me, a frazzled 19-year-old in a poorly fitting suit roaming the halls of 200 West looking for “the data room.”

In the context of startups and venture capital, a data room is a collection of files that an organization compiles in order to provide prospective investors with the information required to underwrite an investment. Investors will typically ask for a data room after a promising first meeting, and such a request typically indicates that the investor is interested in learning more about the opportunity to invest in the current round. Occasionally, investors ask for data rooms in order to collect metrics and learn more about a market opportunity generally, but sometimes it’s challenging for founders and CEOs to weed these folks out from those who are genuinely interested. Later in this piece, I’ll provide some tips on how to run a tight financing process and keep company files secure.

Example data room.

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When putting together a data room, the most important thing to do is to let the data tell the story, not the other way around. The data you provide to investors needs to support whatever broader narrative you are describing and will therefore vary by stage. For example, as a seed-stage company, your narrative might be focused on market trends, regulatory shifts, your team, and other compelling “why now” forces, whereas a growth-stage business might focus on trends in metrics, key accounts and relationships, product expansions, and new business lines. Whatever your stage, make sure the data actually supports the narrative.

The Anatomy of the Data Room

If you remember anything from this piece, remember this:

The best data rooms are concise, accurate, high integrity, and ultimately make it easy for an investor to write an investment recommendation.

Let’s work back from the desired outcome. If you want funding from an investor, your prospective partner will likely have to present your company as a potential investment to their partnership (this is true at most firms, though you should always clarify the process with the investor). To do this, most investors have to provide a long-form articulation of an investment opportunity, and so it’s helpful to make your data room mirror the investment recommendation. Though not a steadfast tip that will guarantee funding, generally in life, it’s best to decrease friction for the outcomes we want.

Here are the key sections to include:

1. Market Research

The goal of the Market Research folder is to include high-level materials that introduce investors to your industry or market opportunity in a succinct fashion. These materials should both educate the generalists and refresh the experts as most companies cast a wide net and engage a number of different firms with varying levels of expertise. In speaking with many different kinds of investors, founders provide a lot of free education. The Market Research folder can help reduce the founder or CEO’s education burden while providing sources for any structural market claims you make.

What to include: consider sharing 3-5 brief research reports to help investors get up to speed. Sometimes it can be helpful to add a quick summary of the takeaways from each document, but this isn’t required. I like when teams share highlighted documents so that I can quickly refer to the most important areas. Make sure the materials you share are relevant and targeted, and the key takeaways should be:

  1. Your company is operating in a massive and growing market
  2. There is a clear “Why Now” for the problem your company solves

In addition to this top-down research, the Market Research folder should include a bottoms-up analysis of your Total Addressable Market (TAM). TAM is one of the most common reasons why investors pass as investors often underestimate TAM, while many suspect that founders and CEOs overestimate TAM. However, investors also often underestimate the ability of strong teams to unlock TAM over time. The canonical example is Uber — some investors thought the market for black car services might be too small, and even the team only showed a $4 billion market opportunity in their first deck. Today, Uber’s market cap is >$52 billion. Obviously, Uber ended up creating a new category of transportation in ride-sharing that expanded far beyond black cars.

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Unsurprisingly, it’s very challenging to predict the TAM for entirely new categories. Believe it or not, most investors are less focused on the sheer accuracy of this analysis (though this matters, directionally), and are instead more interested in how you think. So, the net effect is that investors will likely gloss over the top-down TAM numbers you provided from industry reports — few will care about what McKinsey thinks your market size is, and to be honest, you shouldn’t care too much either. Top-down reports are more for educating the investor on market trends and tailwinds, not demonstrating the true size of your market.

So how do you calculate TAM? There are many great posts on this topic listed below. In general, the formula for TAM is:

Total Addressable Market = Number of Addressable Users/Customers x Average Revenue per User/Customer

Some of my favorite pieces about TAM:

SOM, SAM, and TAM.

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“Founders think of startups as ideas, but investors think of them as markets. If there are x number of customers who’d pay an average of $y per year for what you’re making, then the total addressable market, or TAM, of your company is $xy. Investors don’t expect you to collect all that money, but it’s an upper bound on how big you can get.” -Paul Graham

2. Financials

For Series A companies and beyond, the financials folder is among the most important and it’s essential that you share the right level of financial detail with prospective investors. It’s incredibly frustrating to work with insufficient data (e.g., a company does not break out the Cost of Goods Sold so that the investor can understand levers for growing gross margin) or data that is too granular (e.g., a company shares a raw transaction database but does not have a Profit & Loss statement).

Most investors will ask for similar cuts of data, and these metrics are arguably similar to if not the same as what you already report to your board if you have one:

  • Monthly or quarterly P&L for the past 24 months (in Excel)
  • Forward-year projections with Cost of Goods sold and Operational Expenses detail (in Excel)
  • Balance Sheet (in Excel)
  • Customer or user-level revenue/retention over time (in Excel)
  • Key Performance Indicators (KPIs)

A note on KPIs: Less is more. I'm always impressed when a CEO is “all over the numbers,” but CEOs live in their businesses 24 hours a day. An investor may be spending 2 hours out of theirs to run an analysis. Pick the few KPIs that matter most, share why they matter and explain your company’s performance against them. If you have too many KPIs, clearly some of them aren’t “key.” Emphasize those metrics that inform how you make decisions about the business.

Importantly, KPIs are like vectors: they require a value and a direction (i.e., growth rate).

And, unless absolutely necessary, stick to conventional KPIs that an investor will be able to benchmark against other companies. Ditch weird adjustments (i.e., COVID-adjusted EBITDA), unless you're making a meme.

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3. Sales and Marketing

In this folder, show. Don’t just tell. Be sure to include a copy of the sales deck you use in the wild. Provide a probability-weighted sales pipeline and define the probabilities mapped to each stage. If your company is operating in a competitive market, offer win rates against top competitors on a percentage basis: of the cases where our product is not chosen, x% of the time it is because the prospect went with [insert competitor]. It’s also important to flag if “No Decision” was the ultimate outcome for a prospect.

For customer-level data, show an unblinded customer list (if possible) and account-level revenue over time (e.g., monthly, quarterly, or yearly). Investors will use this data to understand any churn/upsell dynamics. If your product shows net negative retention (i.e. your contracts are expanding over time), include a note as to what is driving this dynamic.

As you progress in diligence, it’s likely that investors will ask to speak to your customers. This can be nerve-wracking for CEOs who don’t want to annoy clients with a bunch of calls from VCs all asking the same questions, poking and prodding around your company’s weaknesses. In advance of fundraising, consider preparing written formats for customer calls based on questions that investors are likely to ask your clients, such as:

  • Why did you choose product?
  • What problem does solve for your organization?
  • Did you evaluate any other products?
  • Are there other opportunities for product to expand within your organization
  • How would you describe the utilization of the platform at your organization?
  • How do you measure the return on investment (ROI) of using [x]?

Once you are at the final stages of diligence with a handful of investors, you might consider allowing 2-3 to speak with current and/or prospective customers. Some founders save these asks for closing diligence, and it’s still best to allow investors to make at least a few calls pre-term sheet, whereas the rest of the calls could be completed as part of closing diligence. The written references should meet the needs of those investors expressing initial interest but who have material outstanding diligence to complete. With consent, I’ve also seen founders include recordings of sales conversations or customer testimonials via Gong or other tools.

Throughout the process, you might consider setting the terms of customer references up front. Some founders ask investors not to ping their customers or prospects without consent. If you don’t mention this, assume investors will reach out.

4. Product (+Engineering)

For the Product and Engineering aspects of your business, generally, investors are most concerned with your current product functionality and roadmap, and what level of engineering effort it will take for your product to get to the next level. Note: this dynamic may be less true for deep technology companies, where much of the diligence revolves around intellectual property and the technology moat.

No matter what your company sells, one of the best ways to drive efficiency in a financing process is to pre-record your demo. One more time for the people in the back. PRE-RECORD YOUR PRODUCT DEMO. I can think of no greater waste of time than to pay your product leader >$200k to do demos for semi-interested investors all day. Your product leader could lose weeks of work doing investor demos depending on how many investors ask. Pre-record the demo on Loom so that investors can watch it asynchronously (and you can track if they actually did), and they can share it with colleagues who may be joining the diligence process at different points in time. You’ll also want to put together a product roadmap either in a slide format or a public portal on Productboard, for example, to walk investors through where the product is heading with this round and what resourcing will be required from engineering.

For companies that are tech-enabled services businesses or biotech companies, this section will look different. Tech-enabled services companies are more likely to provide an overview of operational protocols, whereas biotech companies will walk investors through various programs. Much of the advice in this post can be adapted to these kinds of businesses. Asynchronous communication is king/queen!

5. Corporate Governance

This folder is important, but typically not until later in a fundraising process. In this folder, consider including your:

  • Capitalization table (likely a simple Carta export). For earlier in the process, you can upload the summary version that breaks the cap table down by shareholder (e.g., Seed Preferred, Series A Preferred, etc.) instead of the detailed version. Later in the process, you’ll need to provide the detailed cap table that shows all shareholders.
  • Term sheet from last round (so new investors can draft off of it, if relevant). This part is also for later in the process and typically is only provided when requested by a prospective investor. Some founders choose not to share the post-money valuation with prospective investors (even though it is often easily discernable via various sources). Depending on your approach, be mindful as to when you share your last term sheet – again, typically by request of a serious investor who has verbally extended lead terms and wants to draft a new term sheet off of the last round framework.
  • Terms for any debt on the business, and any additional detail about your business structure or formation relevant to an equity investor.
  • Incorporation documents and tax returns — for most processes, you can leave these out until you’re engaged seriously with a prospective lead. These documents will be relevant during the closing process. It won’t hurt you to include them earlier but don’t expect much foot traffic in this section from investors earlier in diligence.

Sometimes CEOs include full team bios for the executive team in this folder, but a summary version provided in the pitch deck is typically sufficient. Assume investors will meet your functional area leaders as they go deeper into diligence.

6. Industry-specific: Scientific or Clinical Data

I invest mostly in healthcare and life sciences companies, where much of the diligence requires additional evaluation of scientific or clinical data. This information should go into a separate folder. Whether your company is focused on value-based care delivery or KRAS inhibition, make sure that you provide sufficient explanations of the methods and takeaways from any analyses or publications. Again, highlighting the key points in documents is helpful here. A supplemental slide deck summarizing the data is also encouraged.

Common Mistakes

There are a few common mistakes I see when going through data rooms for prospective investments:

  • Obfuscating important data granularity: Often times companies do not provide sufficient detail to understand the key levers. The reason to build an unprofitable company, raise venture capital and take the associated dilution is that you believe your company will become profitable eventually. So, for key line items such as Cost of Goods Sold and Operational Expenses, it’s important to show the contributing expenses so that investors can understand which are fixed vs. variable. Obfuscating this data could send negative signals — first that you are not showing the whole story, but also perhaps that you don’t fully understand the key risks and areas of the business. Be forthcoming about the good, the bad, and the ugly. Your prospective and/or future investors will find out eventually and you don’t want the first board meeting to be a total shock for your new partner. Of course, the onus is also on the prospective investor to do their homework.
  • Sharing fragmented data or unconventional analyses: With data rooms, convention is actually a good thing. Sharing non-standard analyses in lieu of conventional ones (e.g., showing part of a Profit & Loss statement vs. a complete view) is unhelpful. Unconventional analyses should only be utilized to make a nuanced point.
  • Providing too much data: Yes, there is such a thing as putting too much data in a data room. As discussed with KPIs, you want to share the relevant information that is needle-moving for the business. Extraneous data that does not affect the current or future health of the company is distracting and might signal that you don’t have a clear grasp on the levers for your business.
  • Underestimating the competitive landscape: Many teams like to share tables with features that show that their company is the only one with certain features and functionalities (e.g., “Best-in-class Customer Service”) - really? First of all, these charts are sales tools, not competitive landscapes. A competitive landscape includes all companies that are fighting for the same budget your company targets. Be both generous and specific in terms of which companies you include. Don’t underestimate your competition.
  • Refrain from trickling information. Most successful financing processes run off of momentum. You have a great first meeting, the investor asks for data. You send your data room and they like what they see, and continue to follow up with questions. If at any point you don’t have the information ready that an investor asks for, you may have to do some custom work. But preparing a data room using the aforementioned framework will cover 90% of requests. If you go out early and don’t have material ready, trickling information can crush momentum. Fundraise when you are (mostly) ready.
  • Work with a designer for your pitch deck. Self-explanatory. A poorly designed deck that looks like it was made in 2003 Microsoft PowerPoint is going to raise more questions than answers. It’s not that expensive to work with a designer for a pitch deck. If you are having trouble finding an affordable designer, go to design schools like RISD; they often have student-run design collectives where you can hire contract designers for ~$15/hour. The data presentation should be at a minimum, trust-neutral, and if well done, might build a bit of trust.
  • Use a secure platform, but make data easy to access. One of many founder “worst nightmares” is having a VC leak data to a competitor or portfolio company. Unfortunately, this happens, and it’s great that tools like @DocSend exist to help mitigate this behavior. Even still, there are DocSend Chrome plugin scrapers out there that allow investors to download “non-downloadable decks.” However you decide to secure your data room, make sure the investor can download the necessary materials and conduct analyses as needed. Few things are more frustrating to investors than having to go back and forth with a founder because the data room is locked down/not exportable. Also remember that an investor’s greatest asset is not their money, it’s their reputation. No investor wants to develop a bad reputation for sharing company data without consent.
  • Leverage asynchronous communication where possible. Empower investors to ask some of their follow-up questions asynchronously via email. I’ve always wondered why more founders don’t respond to questions with async videos via Loom. Perhaps it seems important to keep everything synchronous to preserve the relationship-building aspects of fundraising. Still, I’d personally love to be able to send over questions as my diligence progresses without having to wait a week to get an entire executive team on the line to go through them, and candidly, this feels more respectful of the founder's/company’s time. I’d encourage more founders (and investors!) to play with these formats, while still prioritizing relationship-building.
  • Include commentary. Relatedly to async communications, sprinkle commentary throughout your data room. Integrating notes/comments into your materials will save your team and prospective investors time to do more work offline (e.g., FAQs for financial materials, notes on accounts in the pipeline). Leaving notes that cover the minutiae can help focus live diligence sessions on strategy and vision. For one of my investments, the founder and I collaborated on a Google document where I could leave questions and he and the team would asynchronously respond as we conducted diligence. This resulted in 40 pages of documentation that ultimately became the foundation for our investment memo, streamlining the process materially.
  • Involve your team. The CEO drives the process, but investors want to meet your functional area leaders too. Include CXOs and VPs in follow-up meetings with investors who are serious when possible. The more people we meet in diligence, the better we understand your culture and build connections with your organization.

That’s all for now. Secure your bag!

Peace and blessings,

Morgan

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Huge thanks to my pals Daniel Breyer and Nikhil Krishnan for reading versions of this post.