Industrial Startups — How To Determine Your Funding Strategy
Startups in the industrial sector face a particularly hard challenge of hitting product-market-fit (PMF) fast. This is due to a variety of reasons:
- Complex Factory Stack, i.e. integrations with different machines/processes/systems.
- Long sales cycles, i.e. many cross-functional stakeholders involved.
- Market readiness/education, i.e. a limited solution or even problem awareness.
Having that in mind, an unclear or delayed PMF means that it will likely be tough for you to show tremendous growth at the early stage, and investors might be hesitant to invest in a business which shows very little validation at the beginning. From my personal experience, even many early-stage investors will want to see revenue progress fast and will often assess you using their “traditional framework”, for example expecting $10k of MRR before considering investing. This can be misleading as industrial startups have the potential for enormous expansion, customer stickiness and a good chance to really accelerate and show very strong growth when they hit PMF, yet many investors underestimate this and are afraid to invest before that stage.
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The way I look at it, the difference in the development of these companies can be easily illustrated in this way:
Funding strategies as you find PMF
Until your startup hits clear PMF there are usually two ways for you to survive:
- Funding strategy A: raising a big round without much traction which provides a long enough runway for you to build the product, acquire some customers and get to early PMF.
- Funding strategy B: raising a small round and focusing on getting a handful of customers — by charging professional services, providing consulting, getting grants and doing whatever it takes to survive. This means you may have to reach profitability at some point to bootstrap for a while until you can hit the growth pedal.
Funding Strategy A: Raise a lot of money — if you can
While this is more an exception than a rule, there are founders who can raise a big amount of money without showing much validation early on. This usually happens to very experienced founders who find investors who believe in their vision and understand that this initial capital is needed to build a big company.
Let’s take a look at a few actual examples:
- OnShape: the creators of Solidworks, which is one of the leading CAD software that sold to Dassault Systèmes for $310M in 1997, started to build Solidworks in the cloud in 2012. Their extensive years of experience building (CAD) software was crucial in helping them to close a $35M round in the first year. The company later on raised $64M even before launching.
- Desktop Metal: the founders raised their first round of $14M after two months and without having a prototype to show. This kind of success was mostly due to the team they had in place which consisted of former engineers from Solidworks, a VP of Kiva System and co-founders of the lithium-ion battery company A123 Systems. The company has raised in total $437M over seven rounds from investors such as Lux Capital, DataCollective and NEA.
However, raising significant money does not always guarantee your success in this industry. Look at Rethink Robotics which raised $150M over the years from investors such as Goldman Sachs and GE Ventures but recognized how challenging it was to build low-cost and robust robots and went bankrupt some months ago.
Something to think about is why these companies that raised a lot of funding early on are all in the US. As stated before, the maturity of the US startup ecosystem and those very experienced founders and serial entrepreneurs are a big reason for that. On top of that, US investors are probably more used to invest a very large amount of money early on compared to their European peers. That being said, a few European investors such as Atomico, that led the Series A at both CloudNC and Oden Technologies, started to adopt similar funding strategies. It’s great news because Europe needs these investors to build the Future of Manufacturing here.
Funding Strategy B: do everything you can to be capital efficient and have a long runway
The majority of founders in your sector will probably have a hard time raising significant funding without showing early signs of PMF. If you fall into this category, you should be very concerned with capital efficiency and you need to be creative and find additional sources of revenues to extend your runway.
Here are a few ideas worth mentioning:
- Adoption: focus on making user adoption a key company strategy. By that I mean you should focus on driving adoption within a few companies rather than getting pilots with nice logos that will eventually not convert. Follow the customers that show little friction adopting new technology even if they are not well-known brands. Especially if you get inbound leads. These customers might have a better problem and solution awareness since they are actively looking for a solution and will move faster.
- Consulting: don’t be afraid to be a consultant. This is common practice in the manufacturing industry. Try to be creative when offering services. If you are implementing a solution it’s okay to charge for that. Try selling a digital innovation workshop for a couple of thousands on top — anything that helps your runway. Don’t educate them for free. Ever.
- Grants: there are many grant programs that support innovation, both on a country and on a European level. Here is a list of some initiatives. I have seen successful cases where startups got more than a million in grants at a very early stage. Getting the amount of a seed round without giving away any equity is a huge win.
- Hiring: keep your burn low. Don’t hire too fast, and incentivize new hires with stock options rather than salary. You don’t need a VP of sales anyway if you don’t have a proper sales team. It’s crucial that the founders learn the sales playbook first before others can replicate it.
- Revenue: try to charge as much as possible initially and raise your prices every time until your qualified prospects resist your pricing. Also, if they want your solution on-premise, make them pay you top-dollars for that, otherwise go on with other leads.
In my eyes, your entire revenue does not need to be recurring at the beginning — it can be one-off — as long as there is a clear path to grow repeatedly and to shift the revenue from service to licenses.
Here is an example of how it can look like:
Since the market is still in very early stages, here are some examples of startups outside the manufacturing industry that followed this strategy — I covered this in my previous blog post here analyzing European SaaS companies:
- Celonis: the Munich-based process mining company began with around $10k, then bootstrapped for five years and went on to raise $27.5M from 83North and Accel to expand into the US market. They achieved growth by helping their early clients understand and improve operational process flows and by charging for professional services. They went on to win a rare Reseller Agreement with SAP distribution, and last year the company tripled revenue to €20M with the goal of IPO in the US in 2020.
- UIPath: this unicorn had very slow beginnings. Founded in 2005, it took them around seven years to reach PMF and scale with their Robotic Process Automation (RPA). Now they are one of the fastest growing Enterprise SaaS company in history.
I hope these examples show you that you are not alone. Great things take time, and many startups that seem like overnight success stories flew under the radar for several years before finding their PMF. Running lean, and capital efficient gives you enough time to build something that is worth getting funded — a version of your product that is up and running and some performance data for investors to evaluate, giving your company greater leverage. Although it takes longer in this industry, there is the potential for tremendous growth later on.
Next up — I will be covering strategies for startups to escape the pilot purgatory in the next blog post.