Due Diligence Data Room Best Practices

By Trevor Lew

During venture capital due diligence, there are many different pieces of data and documents needed to be furnished to prospective investors. The easiest way for a company to facilitate this is to have what’s called a data room.

A data room is simply a place where all the relevant files for a potential deal can be found. Historically, they were actual rooms where hard copies of the files were kept. Today, most transactions use cloud-based data storage providers. Larger transactions use specialized vendors, but most startups use lower cost options like Dropbox, GoogleDrive, Sharefile, or DocSend.

Having a data room is a much-preferred manner of facilitating diligence than simply emailing over responses to requests ad hoc. This is especially true whenever a firm is engaging in diligence with multiple parties. Furthermore, data rooms are much easier to preserve the record on what has been provided which is important for later legal documentation.

In general, it’s best to keep in mind that outsiders are going to be digging into the data room. Therefore, the goal is to try and make the data room as user friendly as possible. Below are some helpful tips on best practices:

1. Logical folder hierarchy – Most venture capital firms have due diligence lists they like to work off of. Having a good folder structure saves time and energy in conforming to that list. Otherwise, it’s a great practice to have good hierarchies to make finding and referencing things much easier. Some examples of folders that we generally like to see are corporate formation documents, material agreements, KPIs, financial info, personnel agreements, and intellectual property documents. Folder hierarchies are obviously dependent on the particulars of the business.
2. Descriptive file names – Have good names for the files. If it’s from a scanner, then don’t call it sd123243. It should be called letter of interest from Customer A or insurance policy from Company B. Dates are very useful too. For example: “Company A P&L Jan 2017 to May 2020” gives a lot of information without having to open up the file.
3. Summarizing memos – Writing memos describing key parts of the business can save time vs. doing a big long explanation verbally. It can be very cumbersome for a CPG company to describe its supply chain in its investment pitch deck. However, a word document or excel file outlining who the primary vendors are, where they’re located, and how long they’ve been used can more easily convey that info. The best part is that it’s now available to multiple parties, so this info doesn’t have to be repeated. Good example topics that can be covered this way are the company’s tech stack, supply chain, go-to-market strategy, intellectual property strategy, and financial reporting processes.
4. Notification of uploads – Have notifications for new uploads on. Most data room providers have some functionality to do this. This helps save the step of manually notifying all the parties of new information.
5. Fit for an outsider – Keep in mind that someone who doesn’t know the company very well will go through this information and likely will need to report to the investment committee. This means that having pdfs instead of Excel or having old versions of things can slow things down. This applies to other things like legal agreements that don’t have key terms included or accounting info that doesn’t tie out. It can be a big lift to scrutinize everything, but the process can get bogged down quickly if the reader of the data room can’t follow the info uploaded.
6. Flexibility to change – Due diligence is an imperfect science, and usually every company has specific quirks to their situation. Often this means there can be unexpected additions on a particular topic. Try to keep the overall structure of the data room flexible.

Data rooms are a necessary tool for the deal making process in 2020. When presented well, data rooms can easily go unnoticed, but when presented poorly, they can have an outsized adverse effect. These quick tips are easy ways to improve the quality of your potential data room. So hopefully these tips are helpful!