Hardware Founders: (When) Should You Try To Raise VC Money?

Eric Migicovsky
Jul 9, 2018 · 4 min read

If you choose to raise any amount of venture capital investment you are making an implicit agreement with your investor that your aim is to grow the company to a valuation of more than $1bn within 5–10 years. Given a typical hardware multiple of 5x, that’s a minimum of $200m in yearly revenue. That is an incredibly large amount of money.

I recently heard a maxim about recurring software sales:
‘Growing from $0 to $1m ARR is impossible, $1m to $10m improbable, $10m to $100m inevitable’

With hardware sales, especially one-off consumer purchases, $1 earned this month has no bearing on future revenue. Unfortunately the effect can actually be the opposite — if you make an excellent long-lasting product, you will not earn another dime from that customer for a while!

At Pebble, we realized (too late) that we were in a ‘hits driven’ business, similar to video games. One hit product needs to provide enough profit to fuel many years of middling success. Looking back, I wish we had done more to grow sales and marketing of our first gen watch (a massive hit with over 1.1 million units sold) instead of solely shifting resources into our next gen watch.

On top of that, each stage of revenue for hardware companies is actually increasingly complex and difficult. We scaled production of 0 to 100,000 watches quite easily with a team of 12 people. But as we tried to find new markets for growth our baseline operational costs (team, marketing, logistics and manufacturing) grew in larger discrete chunks as we hunted for new revenue while supporting our millions of early customers.

What does this have to do with VCs and investment?

VCs (from seed to large institutions) build financial models and raise money from limited partners with the promise that they will return a profit according to the model. As a general rule of thumb, VCs operate with models that require $1bn valuations at an exit like acquisition or IPO. Anything smaller does not return enough profit to cover losses. With a few notable exceptions (Indie.vc comes to mind) this is evidence to support the meme in the HN/hacker world that VCs will push a startup to grow at all costs.

I don’t think VCs should be embarrassed about this, it’s just their business model. The important thing is transparency to founders.

For hardware founders, especially those in the consumer space, it’s important to recognize your choice when raising money from investors. It’s not just VCs either; angel investors almost exclusively want to see their founders grow companies through increasingly large funding rounds.

There are other paths available! Even though hardware is traditionally capital intensive, I recommend starting small. Try to spend as little money as possible launching an initial product for a small audience. See if they like it. Improve. Adjust your marketing. Work towards finding real product market fit. E-commerce has also made it much cheaper and efficient to market products directly to consumers without going through expensive distribution channels.

For example, bootstrapping or taking small (<$1m) investment is a great starting point for building a solid, multi-million revenue generating and profitable business.

Lumos sells a beautiful and useful LED helmet for cyclists
  • Lumos (awesome bike helmets),
  • Moment (mobile photography),
  • Adafruit and Sparkfun (electronics suppliers),
  • Nomad (phone accessories) and
  • Peak Design (accessories for photographers)

If you find product market fit and experience exponential growth, great! That’s the best time to raise money. You know what your customers want and how to market to them. Now you can pour the VC gasoline into the tanks and accelerate.

Some fantastic hardware startups over the past few years backed by VC money.

Simplisafe rocked ADT’s world with a smart, cheaper take on home security

Peloton started with a $600k Kickstarter then grew to $M’s in revenue. Ring and Dropcam built fantastic and affordable solutions to home security before sizable acquisitions by Amazon and Google. Simplisafe took 8 years to get up to speed, but then raised $50m from Sequoia and recently was acquired at a $1bn valuation.

Bellabeat (YC) has built a sizable fitness tracker business by focusing on a narrow niche. Cruise (YC) dismissed haters who said that a few smart engineers couldn’t overpower Google’s self driving car team and were acquired by GM to lead their entire autonomous efforts.

Be aware of the growth requirements that come with VC funding. If you are not already experiencing exponential growth or if that isn’t even your goal at all, consider bootstrapping or financing your business through other means.

If you are considering the VC journey, I would highly encourage applying to Y Combinator (applications open now). YC has seen almost every single path you can take (positive and negative). We can help tremendously as you seek product market fit and after as you translate that success into a growing company.

Thanks to Marc Barros, Yuri Sagalov, Michael Seibel and Geoff Ralston for reading drafts of this post.

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