You had a great idea. You built a great team. You know that hardware is a significant part of the product but also provides defensibility. Then why are you still hearing too many polite declines from potential investors? Here are five practical tips to cross this fundraising chasm.
1) Your Weakness Is Your Strength
Most VCs shy away from hardware because it is harder to scale:
i) you have to manufacture
ii) you have to distribute
iii) you have to get it quite right the first time unlike software where it is much easier to push a fix or update
For those same reasons the barrier to entry is higher. Indeed entrepreneurs who do hardware often find themselves competing with large corporates, rather than other startups. Those corporates play a volume game i.e., they leverage their weight to focus on large-scale production. As a small startup you can win by doing something better, faster, or cheaper — embrace at least one of those credos when pitching to an investor. Ideally not just a little bit better, faster, or cheaper, but a magnitude more, which is how you can convince a VC you can either steal market share or enlarge the user base.
2) Focus On Specific VCs
This is general advice valid for any startup, but especially so when you are dealing with hardware. If you don’t know the VC well, even spending a few minutes on their website, especially the portfolio section, should give a good sense of their comfort level with hardware. You will typically have three options of funds:
- i) specializing in hardware
- ii) very large that are essentially thesis-agnostic ie focus across various stages / verticals / geographies
iii) strategic ones that are looking as investment as a way of partnering or perhaps even acquiring a company
The universe of hardware investors is indeed much smaller than software, perhaps by a magnitude. The good news is the signal to noise ratio is better i.e., the right connections should lead to deeper conversations quicker.
3) Derisk The Hardware
A previous article talked about how you can make your hardware highly differentiated, very affordable, or even give it away. Having a product strategy upfront is even more critical for a hardware-centered startup than a software one, where you can iterate / pivot quicker. Also, building a moat around data is increasingly possible in a digital connected world. Hardware startups, more so than software ones, really need to KYC – Know Your Customer – during their product dev cycle. They need to spend the early years doing market and customer research while developing their MVP and doing concurrent market testing. Moreover, they should have a two-pronged prod development approach – very good MVP for early pilots while also planning for a Gen 2 which is years ahead in features grounded on feedback from early customers.
4) Distribution Is Now Easier Than Ever, Marketing Is Not
Distribution used to be a top concern for hardware startups. Not any more. At Tau we see companies from TytoCare (a handheld exam kit, provided through doctors) to Peloton (a large bike that any consumer can purchase online) demonstrating a brave new world where any company can reach anyone easily. The flipside is that getting noticed is now harder than ever. If you previously needed a large budget to build channels, now you reallocate those budgets for marketing. See if you can show potential investors how you are moving your user outreach from outbound to inbound. One way that VCs often judge is by looking at the LTV (lifetime value) to CAC (customer acquisition cost) ratio — the best companies typically get this number to be between 3 and 5.
5) Amortize The Capital Required
One big challenge with hardware is you need a significant amount of capital upfront, especially to jumpstart manufacturing. Remember that raising equity is not the only way. For a larger startup, especially with assets, venture debt is often an option. An even more common instrument is purchase order (PO) financing, which is an arrangement where a third party agrees to give a supplier enough money to fund a customer’s purchase order. Sometimes the customer itself does that, often conditioned on milestones such as deliveries of a certain number of products. For very early stage firms non-dilutive grants are often a viable option. These can be in the form of (a) translational research grants at the university level, (b) co-development ones for early stage work, or (c) straightforward non-profit/corporate CSR / foundation level grants for clinical validation and pilot testing. Reducing the overall capital requirements may be hard but showing an investor you have ways to spread it over the years will make your startup more attractive.
Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.
