Investment issues for hardware startups

SKTA Innopartners blogpost by Ilgiz Akhmetshin, August 6 2014

It is widely accepted that the hardware startup funding ecosystem is broken. There are a lot of reasons why investors hesitate to invest in hardware (and even more so in semiconductors):

·         High R&D expenses

·         Longer time-to-market

·         Expensive proof of concept

·         Potential manufacturing issues

·         Expensive to scale, etc.

Therefore, most VCs won’t consider investing in semiconductor companies. Given these reasons, even with the best material or the ultimate chip, fundraising is very tricky, if not impossible. A typical semiconductor startup requires about $5M of seed funding to validate the design and to get to proof-of-concept on an FPGA and then an additional $20M to launch the product. Although this number may vary from one startup to another, it will always be order of magnitude more costly and take longer to reach commercial viability than a software startup. Usually, entrepreneurs can invest their own money or raise angel funding to get started. However, to become venturable, a hardware startup requires much more. Here are a few ways of raising additional money. 

Venture Capital 

Although there are a number of VCs who have recently invested in consumer hardware (e.g. Menlo Ventures, Highland Capital Partners, Samsung Ventures America), extraordinarily few will invest in the early stages. Early stage semiconductor companies may not have much more than a concept and some gross calculations. Armed with only this, it’s much too early to seek VC funding for a traditional Series A round. To become “venturable”, they will have to find $1M-$5M to get first prototypes or at least simulations run. 

Crowdfunding 

Recent success of hardware startups on Kickstarter (Pebble – $10.3M; Form 1 – $3M),  or Indiegogo (Ubuntu Edge – $7.4M; Scandau – $1.6M) prove crowdfunding can be a viable source of startup funding that does not dilute founders’ equity. Moreover, projects not only get funding, but also PR and a customer base. However, crowdfunding is only viable for consumer electronics and devices. We should keep in mind that Kickstarter’s and Indiegogo’s models work this way:

1.       Backers pre-order products or services from a startup

2.       The startup uses this money to start manufacturing

3.       Backers receive pre-ordered goods or services

This works perfectly for consumer devices, but won’t work for any upstream hardware. There is hardly any consumer who needs a single next-generation bluetooth chip if it is not integrated somewhere. Other crowdfunding options include gust.com, angel.co and f6s.com. When the JOBS Act takes effect, everyone may invest in startups via crowdfunding platforms (today, it is limited only to accredited investors who meet special accreditation requirements). Even though these platforms bring more potential investors to the table, it is unlikely that b2b oriented startups will be able to benefit from this opportunity. Consumers are not moved to invest in “holy grail technology”, such as EUV light sources, for example, because they don’t understand the device and the benefits to solving the lithography problem are too far removed.

Seed funds / Accelerators / Incubators 

There are quite a few startup accelerators that focus on hardware. Some of them are affiliated with major semiconductor or hardware manufacturers. This partnership can be beneficial for startups in multiple aspects; strategic partners can bring industry and technical expertise, seed funding and opportunities to scale up (Read the original post to see a list of US based hardware accelerators).