Crowd funding traps hardware in a Valley of Death. What can we do about it?
I recently left my job to pursue a hardware project full-time. We’re working hard on finishing up prototype development and close to realizing our MVP. That means that we need to start thinking seriously about how to fund production of our product. We’ve bootstrapped through multiple prototypes and rounds of testing, but we will need more funding to grow meaningfully due to the high upfront costs for producing hardware. An accelerator would help us get further down the road, but the funding isn’t large enough to get to production.
So what other options exist?
In speaking with people across the industry — from operators to investors to people just getting started like myself — I’ve found that there aren’t many options to finance hardware past the early stages.
However, most often I’ve been told:
Go Run a Kickstarter.
Or an IndieGoGo. Or whatever your platform of choice is. It’s great advice on the surface because crowd funding campaigns provide the two things very young projects need most:
- Exposure (leading to more of #1)
You may even be auditioning for venture capital. But there are a number of problems with this approach — first and foremost one does not simply ‘go run a Kickstarter.’ A successful campaign means investing significant time and resources into the video, copy, graphics, rewards, marketing, and shake down of loved ones.
If you manage to meet your campaign goal, you’ve likely traded the frying pan for the fire. Though the statistics are slightly dated, around 75% of projects deliver late and some never deliver at all. Why is this the case? Though there will always be bad actors, I believe that the majority of folks are acting in good faith. The simple fact is, they get railroaded by the unavoidable economics of their campaigns and end up in the Valley of Death.
Economics of Production
Let’s take a closer look at the economics of a crowd funded campaign by constructing a simple example. Imagine you want to build a moderately sized, decently complex widget. It’ll need, at the very minimum:
- Die-cast aluminum enclosure + finish machining — $30/ea
- Electronics boards — $2/each (no custom chipsets & no radios)
- Misc + Assembly — $10/each (fasteners, labeling, labor)
- Packaging + Shipping — $10/ea
You’ll need $100,000 for upfront capital costs alone (molds, production setup, training, etc) which you plan to cover by selling your $50 widget. There are two ways to do this:
- Sell tens of thousands of units in rewards. An unlikely gamble since the majority of tech projects successfully funded on Kickstarter raised less than $10,000 (see Fig 1):
2. Increase the margin (price) on each unit, as shown in Figure 2 below, using our example widget. This is a better option but you’re now asking your earliest and most fervent backers to pay more for a (likely) poorer quality version of your product. And since Kickstarter is increasingly seen as a storefront for preorders, you’re going to have a hard time selling your new, unproven product for twice the MSRP.
And though the latter option is better, at a hardware-standard 40% margin, our example campaign needs to move more than 7,800 units to overcome upfront capital expenditures of $100,000. Keep in mind that this widget is very basic, not all true costs are accounted for, and the $100k in sunk capital is low, if anything. Of course, costs also drop with volume but you’ll need to land in the top echelon of Kickstarter projects for those advantages to really kick in.
Though this was a ridiculously simple example, it shows the how the economics of Kickstarter as a production funding platform fail us. The majority of crowdfunded hardware projects end up in this Valley of Death where they have momentum, exposure, and a seemingly great pile of cash but not enough to clear the hurdles of setting up production. Note that this example didn’t include the costs of paying your team or setting up a basic office. A more complex example, using 3D printers, backs up this conclusion.
Venture Back For Success?
Kickstarter is often suggested to me as a way to demonstrate traction in order to court VC’s down the road and no wonder why — Oculus, Coin, and even Pebble (the poster child for using crowd funding to avoid VC) all raised rounds or were acquired after their runaway crowd funding successes.
But this is a dangerous gamble to make: of the 443 hardware projects that successfully raised more than $100K, only 42 of them (~ 9%) went on to raise VC. That leaves better than 90% stuck in the Valley of Death scenario laid out above.
So not only are you extremely unlikely to raise VC after your campaign, you are also very unlikely to have raised enough capital in your campaign to clear the upfront hurdles of mass manufacturing. You’re stuck in the Valley of Death; essentially dead in the water. At this point you should return the money to your backers to save whatever goodwill you can.
These scenarios paint a bleak picture, but there is an alternative.
Pre & Post Crowd Funding
How can we get out of the Valley of Death while still taking advantage of the revenue and excellent exposure crowd funding provides? Pre & Post Crowd Funding could be a solution.
- What: a small bet made by an investor ($30,000 to $50,000 for 3% — 5%)
- When: anytime between conception and the point the MVP is crowd funded.
- Why: to finish developing tech and run a killer crowd fund campaign. Upgrade your prototype from cardboard & duct tape. Get a real video. Hire a marketer for your campaign. The choice is yours.
- Investor Advantages: get early access & preferential terms to otherwise unseen new projects; diversify — you can make 10x bets for less than a seed round; make your investments prove real engagement before sinking a large round into them, first dibs on the post-crowd funding when momentum is high.
- Entrepreneur Advantages: You get money aka life blood! This provides a path forward, better prototypes, better crowd funding campaigns, and a higher chance of success.
You may notice that these terms are very similar to those offered by many accelerators. The difference here is that you are explicitly driving to a crowd funding campaign rather than a demo day and the hope of follow-on VC funding. Accelerator backed hardware projects often need to raise again shortly after demo day since the funds they have are not sufficient to go to manufacture or staff up. Therefore, they may find themselves on Kickstarter and end up in the Valley of Death like everyone else.
- What: a more traditional seed round of $500,000 and up to allow the hardware team to get into production faster and with less error, allowing better fulfillment of the crowd funding pre-orders.
- When: right after the crowd funding campaign ends successfully and only if the meets the agreed upon terms or minimums initially agreed upon (e.g.: raised >$50,000 on Kickstarter, sold >2,000 units, etc).
- Why: Allows entrepreneurs to pay for high upfront production costs after proving demand on Kickstarter. Also helps mitigate potential investor concerns about the high cost and binary outcomes of backing hardware by demonstrating demand and establishing momentum.
- Investor Advantages: Your early investment of $20k is revenue positive and showing traction after only a few months. Since the terms of the post-crowd round were settled upon before the Kickstarter began, everyone can focus on delivering product and growing the company.
- Entrepreneur Advantages: Pole vault across the Valley of Death — you won’t join the 90% of projects with no follow-on funding nor those trying to survive only on ‘digital thank you’ and t-shirt rewards. The initial production barriers are removed which allows you to staff up, secure tooling, produce manufacturable designs, and absorb inevitable errors or schedule shifts. And congrats — your Kickstarter pre-orders are truly that, meaning you’re revenue positive from day one.
By structuring the rounds this way, folks on each side of the table can focus on what is most important. Investors get traction, a team motivated by results, and a cheap way to weed out the projects that the crowd rejects. Entrepreneurs are able to price their product at MSRP during their campaign and offer ‘early bird specials’ as an incentive without killing their margin. This helps them align with backers’ expectations and run a stronger campaign. Plus they get to focus on what’s most important — hitting production schedules, delivering a killer product, bonding with their community, and driving more sales.
Let’s go be crazy people.
The world of crowd funding is still changing fast. Less and less can you offer a beta product and have folks understand that they are supporting a work in progress. They want the polish of Apple in the time of 5 Minute Rice. If folks want to treat Kickstarter as a storefront, let’s at least come prepared to do business with a solid financing plan and a pathway to profitability.
I’m like any other maker: I just want to build great hardware. And though funding issues can seem miles away from builders like us, we must have a pathway to our users that makes sense for everyone involved: builder, backer, and buyer. Let’s dispose of the notion that running a crowd funding campaign on a wing and prayer leads anywhere other than ruin. And let’s ask traditional investors to work with us to find the model that makes sense. Then we can get back to what we do best.
Slings, arrows, questions, etc all appreciated. bmkellie at stampteg.com