Why Software investors are scared….

Philip Haasnoot
Jul 24, 2017 · 9 min read

If you are currently running a hardware company in the US it should come as no surprise to you that Software investors are afraid of investing in Hardware. You’ve probably had numerous conversations with investors interested in your idea up until they realize there is a hardware component.

If you read the title as a software investor I probably hit a bit of a nerve which is why you clicked through to read this and shake your fist at what I have to say.

I wanted to craft this article to go through the reasons why software investors are afraid of hardware, and to provide some clarity into the process in an attempt to convince some of the Software investors reading to invest in Hardware.

The path forward is not as clear for Software investors as it is for Hardware Entrepreneurs

1 | The Fog of war

The first hurdle facing investment in Hardware is the unknown path ahead. Software investors fund companies that they understand, and the immediate reaction from Hardware Entrepreneurs is to try and explain their product in more depth; however Software Investors are not as much concerned with the product as they are with the path to market. Hardware startups fail to understand that Software investors generally made their money in the software game and fully understand the entire process of getting a software product to market. The particular product doesn’t matter to them, as long as the software startup has a good idea of what the end product is and has a good starting tech team, the software investor knows what resources they will need to get them to market. When a software investor looks at the hardware startup they don’t even know where to begin. Regulatory testing, manufacturing, R&D, durability testing are all foreign to most Software startups and by extension software-centric investors.

I generally break the hardware R&D process into three distinct phases:

Prototype — At this stage you are using development boards crammed into a crudely made housing to illustrate the main functionality of your product. It has limited functionality but gets across the important functionality to get feedback from your target market.

Pre-Production — Custom PCBA’s (Printed Circuit Board Assembly) in a refined 3D printed or machined mechanics. At this stage you are refining your PCBA designs and adding vital features to get closer to a production ready design. Your mechanics should be finished in design but rapid prototypes to test fit and function.

Production — Finalized PCBA’s with production ready mechanical components. This would be the stage where you own injection molds, have all of your assembly drawings, and potentially a turn-key assembly house to hand everything off too.

This is clearly a simplistic view of the process and there are hundreds of incremental steps that occur in each of those 3 phases. This is why Software investors eyes often glaze over at the mere thought of hardware. Some investors are lost causes and will never be willing to wrap their heads around the intricacies of bringing hardware products to market, for those with open minds I implore you to keep reading.

2 | The technology knowledge gap

Ask a software investor to list the programming languages they know, APIs they have used in their various startups, or cloud storage solutions they have experience with and they will probably chew your ear off for a few minutes listing names and sharing experiences. Now hand that same investor a development board and ask them to load some firmware onto the target device, chances are they wouldn’t even know where to begin. There is a grand canyon sized gap between software (web and mobile application dev) and Firmware when it comes to skill set. Not knowing how far it is to the finish line is disconcerting, not being able to understand how to even progress to the finish line is downright terrifying. From the investors perspective they wouldn’t even know what kinds of engineers would be required should your original team fail, or how much all of this extra manpower would cost.

In the software world they would know how to fill skillset gaps, need a node.js dev? Looking for a server database manager? In desperate need of software pen testers? A software investor will know where to look for these assets, and they will probably already have a list of consulting firms they can lean on when the chips are down. Take that same investor and ask them to go find a hardware engineer with FPGA experience, a manufacturing expert with high volume electronics experience, or an injection molding wiz who can get them to production tooling in one iteration; Those sure-headed software investors with millions in the bank will likely shy away from that kind of task for a simple reason…

3 | Sticking to their comfort zone

There is something to be said with sticking to a safe environment, somewhere that you find familiar and welcoming. However this is not where we learn and grow, and for the hardware startup being outside of our comfort zone is a daily fact of life. However for a software investor that is sitting pretty with a large bankroll this is not a risk they are often willing to take, because it will mean they have to learn a great deal about the hardware process in order to even communicate effectively. Very few investors will toss the cash-grenade over the proverbial wall and wait to hear the explosion, they want to be involved and devote time to ensure their investment bears fruit.

So now that we have covered some of the major hurdles facing a software investor let me provide some insight on how to make this relationship not only bear fruit, but put a software investor in a position to benefit off of the hardware scene.

The path may be steep and winding, but the view from the top is worth it.

Lets dive into some solutions to try and bridge the gap between hardware startups and software investors.

The first mental hurdle to overcome is to realize that no hardware in the modern world is devoid of software, and just as all hardware contains software no software can run without hardware. Even worse yet is the age of interconnected devices, which are the unification of hardware and software. The two are intertwined and placing yourself on one side of the fence will only lead to cutting yourself off from a vast array of opportunities. You cannot believe in the world of IoT if you neglect to respect the significance of hardware.

With that said I obviously don’t expect the majority of Software investors reading this to suddenly see the light, especially those who have had bad run-ins with the hardware community in the past. My intention for the remainder of this article is to provide some suggestions to enter this space with minimal risk and maximum potential.

1 A | There is strength in numbers —

If you have ever shopped for a used car one of the the most important things you should do is have a trusted mechanic take a look at the vehicle. The mechanic is going to understand what the true state of the vehicle is before you even drive it off the lot and will give you a deeper understanding of what you are getting into. This obviously does not remove all risk to buying the vehicle but gives you confidence that at least the major potential problems have been mitigated. Investing in a hardware company is no different and depending on what stage you are getting in at there will be different red flags to look for (Which I may explore in a future article). Get friendly with trusted engineers in the hardware space who have been through the process before; people who have seen the good, the bad, and the ugly side of hardware who can give you unbiased advice.

I have a policy with any investor I know in AZ, buy me a decent cup of coffee (Read: NOT Starbucks) and I’ll sit down with you to go over whatever hardware related questions you have. I do this in an effort to foster a better relationship with these software investors even if they are not interested in investing in anything I have going on at the moment; Because the more they understand about hardware the more likely they are to invest in it across the board. If investors stop putting money into hardware companies in your ecosystem, it will turn into a wasteland of dating and “Uber of X” apps….

Bringing someone into the picture from the outside, who is looking at the product/service from an unbiased perspective will yield better feedback in 15 minutes than you will be able to ascertain with weeks of research. It generally takes me less than 10 minutes with a product or team to know if they are full of it. This isn’t to say my investor contacts always listen, but after losing $150k on a bet I told him not to take I’m sure he will not brush off my criticism in the future. Don’t ask me questions unless you want an honest answer, find someone like this in your ecosystem and you will minimize your risk dramatically.

Sugar coating doesn’t make the hardware medicine go down, it just makes you lose money.

2A | The team is EVERYTHING

Nothing will crash a hardware company faster than a team that fractures and sends the plane spiraling out of control. Making it to market with your product is only half the battle, there will be near-constant design iterations and improvements once your customers get their hands on the product; and more manufacturing fires to put out than you can shake a stick at. The biggest factor for success will be a small, lean, mean team of talented engineers to get you through.

Good team does NOT mean large team, be extremely cautious of startups with a dozen engineers working on hardware. It has been extremely rare throughout my career to work on a large team of engineers even at large corporations, and in the startup world this usually means they are compensating for something. Generally speaking the large teams I have encountered come out of university cap-stone projects, where the school groups together a slew of engineers onto a project that after graduating seems to “have legs.” Often times these large teams of engineers reach out to consulting groups to help them as they have little experience in the real world and majorly bloated egos from the soft supportive university nest they just left. Without their university propping them up and cramming them down the ecosystems throat they would fail immediately; your investment may only help them to hobble for a few more months until they are eaten by a large corporation that takes them in for cheap.

Once again bring in someone you trust who understands what it takes to build a team and let them speak to the engineers you are thinking of investing in. It doesn’t take long for skill gaps to become apparent in conversation and a skilled engineer will rapidly point out false assumptions in terms of time and capital required.

3A | Risk and Reward

I often roll my eyes when investors tell me they “Only invest in software” because they are the same people who buy stock in Apple, Nest,or Microsoft. They are the ones touting the “IoT revolution” despite not understanding that IoT is a marketing term (I will save that rant for another day). They are the idiots who invested in a juicer that doesn’t juice, more on this in the next article. Hardware is difficult because you have to deal with the physical realm, which means human error can ruin your day. Distribution requires real hands (or robots) and physical goods, inventory, and shipping costs. However at the end of the day successful hardware companies provide long-term stable wealth to investors. The primary barrier to creating a hardware company is also your best asset as an investor. Hardware might be difficult, but it’s difficult for your competitors too.

Software investors often look at future investment in terms of what they will be able to re-use code wise from one to the next. In hardware this is the team, and how great of a team you can build will make follow-on projects that much easier. If you have a rock-star electrical engineer you can tap for any future project, or a mechanical engineer who you know will get you to market; future concepts brought to your attention have much less risk. This is the main barrier to entry that you must overcome, and building a team over the course of several investments will put you in a position where you can invest in teams that you have 200% certainty that they will get to market.

In summary — Stop being scared, find a trusted adviser, and build a team you can rely on to get products to market.

Philip Haasnoot

Written by

Multi-Discipline Engineer, Serial Entrepreneur, Glitch in the Matrix

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