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).

4 Things Investors Need to Know About Your Startup

Entrepreneur blog post by Sharon Wienbar | December 26, 2013|

Angels, venture capitalists, private equity firms and mutual funds all evaluate investments on the same four basic criteria. At the various stages of a company's evolution from brilliant-insight baby to billion-dollar behemoth, those investors will weigh your attributes differently.

When you pitch your company for funding, focus on these four topics:

Our strategy is sustainably differentiated.

Demonstrate what's special about your company and how you'll keep that strong position. Is your offering fresh and different with a unique solution for the customer? Are your costs structurally lower or your service super fast because you invented incredible algorithms?

Show that you have something different from the pack, and that is what your target market wants. Some businesses grow and thrive with execution being their main differentiator: think high-volume selling or complex logistics businesses. If execution is your pitch for why you're different, be sure your track record backs that up.

We are the right team for this endeavor.
For early stage companies, the team is the most important aspect an investor considers, as your market and product may not exist yet. What unique combination of skills and experience makes your leaders the potential winners? As you scale your business, your execution will demonstrate why you're right for the job.

Our business model will make money.

Money -- profits and cash flow -- are ultimately what create value. On your way to profitability, your company may become strategically valuable, and might be acquired early or IPO when public investors believe you will become profitable soon. You have to show how your business model -- the costs to acquire and serve customers -- will be profitable. Understand the margin structure of comparable companies, and show how you will track versus their paths.

Later-stage companies and investors focus on the financials. Public investors might screen almost exclusively on your financials, looking for expanding margins and profit growth. For younger companies, your target model and cash needed to break even are foremost concerns.

Market size.

Investors want to know that your company has plenty of room to grow. "You can't make a big company in a small market," was one of my first VC lessons. For the nascent markets startups try to create, there is no current market size, so focus on the total addressable market. TAM measures the potential annual revenue for your industry -- it is NOT an estimate of your company's potential.

Markets can be sized "bottoms up" or "tops down." Try both methods to check if your assumptions are reasonable. Typically, tops down-sizing crudely estimates a market by analogy or relative sizing, e.g., "Product X is a management solution for customers using technology Y. Technology Y is a $1 billion annual market, and an add-on management solution deserves 20 percent of the core target spend, so the TAM for Product X is $200 million."

Here's how Scale Venture Partners created a bottom's up TAM to assess our investment in online marketing company Omniture: We counted websites by traffic volume, assigned an annual revenue potential to each size category and added it all up to over $1 billion a year of annual addressable spend. This work was done when Omniture had only a few hundred customers, not the many thousands of potential clients we counted in our TAM.

As a long-time venture investor, and previously the head of investor relations for two public companies, these four factors are the pillars of successful pitches -- and investment decisions.

Clearly communicate your company's market, strategy, model and people, and you'll be speaking your investors' language.