This is what Investors look for in a Hardware Startup

Tarun Kalia
Oct 17, 2017 · 8 min read

Looking to raise funds for your consumer hardware startup? Here’s what you should know.

Hardware is hot (or cool! — however you define exciting).

About 56% of the 382 consumer hardware startups that the report analyzed, raised their first funds through crowdfunding, with a median size of about $210,000 — which doesn’t provide enough runway to support manufacturing, sales or marketing costs.

As per data from CB Insights, 2016 was a record year with almost $4.4B invested into consumer hardware across 624 separate deals. Q2 2017 saw nearly 140 deals and $1.2B in funding to consumer hardware startups.

Hardware startups are capital intensive and the continued interest from investors is good news for startups looking to fundraise. But what do investors look for in a hardware startup?

Here are the six factors that can influence an investor’s decision to invest in your startup.

  1. How Capital Efficient Are You?
Reasons why it has become easier to start up in Hardware

While the cost of starting up a consumer hardware company is lower than it has ever been before, there is no denying that hardware companies are capital intensive. They need funds at almost every stage of their lifecycle — from iterating prototypes with users to mass manufacturing. Usually, their success can be proved only after significant capital has been invested, making the investment risky and often a barrier to investor interest in such businesses.

Capital efficiency, or a relative measure of the funds needed to build and scale a business, becomes a key consideration for an investor.

A company that has a high capital efficiency multiple (= latest valuation or IPO market cap/funds raised), provides better returns for its stakeholders. More the capital requirements to build and sustain a business, riskier it becomes to support it.

Successful hardware companies have high capital efficiency multiples. Have a look at these numbers presented by Jerry Yang, General Partner at Hardware Club.

Facebook: 36x
Twitter: 22x
Uber: 5.7x
Airbnb: 9.4x
GoPro: 13x
Oculus: 21x
Nest: 40x
Fitbit: 91x

Staying capital efficient can imply that;

  • A company may be able to come up with near production prototypes without raising funds.
  • They will have lesser probability of suffering from “feature creep” as they would use funds wisely enough to not add anything unnecessary to their product’s features.
  • Their decision making will be more biased towards making the product successful even if that meant focusing on smaller, niche markets (rather than chasing mass markets in order to return multiples on investors’ money).

2. Do Customers Want Your Product?

Crowdfunding platforms have truly emerged as go-to for founders to raise the initial proof-of-concept capital. Entrepreneurs increasingly use crowdfunding campaigns to assess the market readiness of their products. There are several companies who are opting for the crowdfunding platforms after raising seed or VC money, with the objective of evaluating consumer interest in their products.

It was through their campaign on Indiegogo that Misfit Wearables found a huge customer base in overseas geographies. Oculus, that was bought by Facebook for $2bn, first raised funds on Kickstarter.

The success of a product cannot be ascertained only from a crowdfunding campaign as we saw in the case of Pebble and Coolest Cooler. But as platforms mature and backers understand the feasibility of projects, the trend of crowdfunding being used as GTM strategy by startups will continue.

Thus VCs will continue to be on the lookout for that ‘viral’ crowdfunding campaign that may uncover the next million dollar company.

3. Team

This one is almost a cliche yet critical and worth a mention. Team ranks very high on what investors look for in a startup. Given the complexities involved, it becomes even more crucial to hire the right set of people in a hardware startup.

Typically, a hardware company would need skills such as industrial design, mechanical engineering, software/firmware and electrical engineering. Depending on the product, there may be specialized skills that a company may need. In case of connected hardware companies, additional skills such as Machine Learning, Data science, etc will be needed.

The speed of execution is critical for a hardware product for mass consumer adoption. The supply chain for a hardware startup is complex. Outsourcing parts of the supply chain to foreign countries in order to save cost and leverage specialized, local ecosystems is commonplace among hardware startups. It is therefore invaluable to have experience in supply chain management, esp dealing with foreign contractors and factories.

Mistakes can be costly in a hardware startup. While a software company can release updates to fix issues, a hardware company has no chance at fixing mistakes as easily. Pivoting can be costly and nearly impossible for a hardware company. The overall process of bringing a product to market is harder for a hardware company. Thus, having the right team is imperative for a hardware company.

4. A Strong Exit Strategy

A lot has been going on in the consumer hardware space, proving that it is not a dead end. There has been a proliferation of hardware focused funds, growth in investments and some modest and a few strong exits. The overall investment ecosystem is maturing.

Tech giants are pouring billions of dollars to invest in developing their own hardware or acquiring companies to lead the hardware revolution.

These are certainly indicators that the consumer hardware dream is alive and well! Entrepreneurs must focus on execution of their ideas and should have an Exit strategy in place.

5. Business Model

A question that every investor will ask you is: How will you keep your customers coming back to you?

Here are a few strategies.

Hardware, Software and Services play

During Apple’s Q2 FY 2017 results announcement, its Services segment — that includes includes the App store, iTunes, Apple Music, Apple Pay, iCloud and Apple Care — clearly stood out, although the results are driven by iPhone sales.

So, why does Apple sell services? Apple’s services business generated $7bn in revenue in that quarter, making it the company’s fastest growing segment. But that’s not the only reason.

Apple has a tightly-knit hardware, software and services ecosystem that works well. Largely driven by the App store, Apple’s services segment helps the company sell more products. The app store was called “one of the best business models ever created” by an analyst. It locks in customers and creates loyalty for the brand.

Google acquired Nest and Motorola mobility, pointing to how hardware is powered by software.

Hardware Enabled Service

If you are conscious about your health, chances are that you own a Fitbit device. If you are very passionate about it, you may even have a subscription to Fitbit’s premium services. Fitbit’s paid subscription provides users with a digital trainer, audio coaching, guided health programs and more.

Dropcam that was acquired by Nest, provided wifi enabled security cameras with live video streaming. The company offered a cloud storage service that saved recorded videos for consumers to watch at a later time. The customers pay for the secure cloud storage component and the company is able to retain them in its ecosystem.

Hardware -as -a-Service

Square provides a card reader device that can turn a user’s smartphone into a credit card machine. Merchants can therefore accept offline debit and credit cards on their phones or tablets. It offers its card reader for free but charges users for using its payment processing technology by charging a fee for each swipe transaction. In addition, the company offers several tools and services to small businesses.

Consumables

Kraft Tassimo Coffee System is a coffee brewer that uses proprietary beverage pods to prepare single-cup servings. The customer buys the dispenser (hardware) once and keeps purchasing the pods (consumables) to be used on the machine. In some cases, a company may sell the hardware at a very low price or even at cost to acquire the consumer and make up for it by the recurring healthy margins on the consumables.

Investors are looking for differentiation. More investors are investing in not single devices, but suite of products that are tied into an ecosystem of software and services, generating valuable data, creating customer stickiness and generating consistent revenue. It works well for the company as customers are invested into the hardware and using a competitor’s offering will cost more money.

6. Is your business tenable?

Hardware can be replicated and commoditized. A company may bring a unique product to market and may be pared down by competitors (or copycats).

The power of Network Effects

GoPro didn’t just sell cameras — it sold great experiences. The company initially sold to surfers, who usually rode in groups and would share their experiences later. With GoPro, members of the group could capture their experiences from different angles and could bring them to life over and over again. GoPro became a huge success, rapidly diversifying to other sports.

Similar to GoPro, Fitbit let users track and share fitness goals, achievements and stats with friends. It enabled users to support, motivate and compete with each other, thus creating massive user engagement. More people bought the device and engaged with the community, and anyone with a bucket list of fitness items used Fitbit as their platform of choice.

Read more about network effects on this presentation by Andreessen Horowitz.

Strong User Community

MakerBot, the 3D printer manufacturer company, created and nurtured Thingiverse — an online community to encourage members to share digital designs and content. Thingiverse is today the largest open source community for design and the largest community for 3D learning. It continues to provide immense value for MakerBot’s proprietary products.

Several other companies such as Oculus, Leap Motion and Xiaomi are nurturing user and developer communities. An engaged community creates a competitive moat that is hard for competitors to replicate. A copycat may copy a hardware product but that may not guarantee that customers will switch.

An engaged community creates brand advocates, positive word of mouth and an opportunity to directly engage with customers. This implies reduced customer acquisition and marketing costs and investors value those metrics too.

A growing community of investors is warming up to the idea of investing in more than just lines of code! They are beginning to understand and appreciate the complexities of hardware product development as well as the associated costs, risks and returns.

Tarun Kalia

Written by

Product Design & Development for Hardware Startups ▶www.outdesign.co

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