Dangerous Mistakes that could Kill your Hardware Startups
If you’ve not brought a hardware product to market before, there is unfortunately a lot that you don’t know. We frequently see founders trip up in a few key ways:
1. Spending time and money on patents pre-institutional funding
There are a lot of hardware founders who worried about their idea and focused on intellectual property in the early days. If you haven’t raised money from institutional investors (VC) yet this is usually a waste of time and money. By the time patents are issued the market opportunity and business often don’t exist anymore. Or, the product has changed enough that your initial claims don’t apply. Usually the only time utility patents become useful is during an acquisition (they’re an intangible you can negotiate with for more $$) or if you’re super successful and large enough to finance litigation. Then you can actually afford the millions of dollars and years spent suing someone.
Prior to raising institutional financing, founders are almost always better off spending the average $35K+/patent and 3+ years until issue on marketing, staff, or manufacturing.
2. Treating contract manufacturers like service providers
Factory owners are highly cognizant of opportunity cost. The best contract manufacturers are not, in fact, dying to take your order. Stable orders from a large company are always more attractive than working with startups.
Pitch contract manufacturers with just as much care as you would any VC and investors. Since you likely can’t lure them with high volumes, many factories are looking to broaden their product portfolio and capabilities. For example, the toy industry has struggled in recent years and many toy manufacturers in and around Shenzhen are interested in getting into consumer electronics. Generally, the better the factory, the more discerning they are. Visit them regularly and build a real relationship. How can you help each other grow?
3. Not having a handle on cash flow Inventory creates complex cash flow issues for hardware startups. It’s not unusual to pay 50% upfront and 50% on delivery with a contract manufacturer. It’s also not unusual for a retailer to issue a purchase order with 90 day payment terms. This means many hardware startups are fronting cash for 3–6 months of inventory, all paid for by equity. Equity investors HATE paying for inventory. They’d far rather have their money spent on something that actually increases the value of the business, like hiring great people.
Know what unit volumes unlock better factory financing. Getting access to net 30 or net 90 day terms with a contract manufacturer is transformational. On top of this, many founders are unaware of all the dynamics of retail. Do you understand sell-in vs sell-through? Program costs? Factoring? Who pays for returns?
4. Spending crowdfunding dollars on product development
Kickstarter and Indiegogo serve a valuable place in the hardware funding ecosystem but pre-sales are closer to debt than equity. Every dollar you “raise” must be repaid with product. Because pre-sales are often the first money a young company brings in, it often gets confused with equity financing. You even hear it in the way founders talk: “we raised $1M on Kickstarter.” In reality you haven’t raised any money at all, you’ve pre-sold product.
Because it’s highly unlikely you’ll make money off your first few thousand units, only crowdfund once you’ve completed product development enough to know your BOM, COGS, fixed costs, and distribution margin. If you don’t, you risk a hoard of angry backers at your door with pitchforks.
5. Not allocating enough money for marketing in your first institutional raise
Just like product development, figuring out a winning customer acquisition strategy is iterative. Founders are often so focused on getting first units out the door that almost all of their initial money has goes towards engineering hires. Marketing or distribution hires focused on customer acquisition and scale are often overlooked. Budget to hire a great sales/channel distribution person as part of your first institutional raise. This is more important than having a full stack engineering team in house.