In the not-so-distant past, venture capitalists routinely refused all requests from hardware start-up companies. That has changed somewhat, thanks to advancements such as digital fabrication, 3D printing, and availability of inexpensive components to build prototypes. However, 90 percent of all new funding requests through venture capitalists and angel investors still go to software rather than hardware start-up organizations.
The cost of creating a prototype and manufacturing a new hardware project remain the top reasons that traditional investors shy away from them. It requires tens of millions of dollars to get a project to this stage, which is significantly more than the typical software development project. Mass production of hardware can be costly as well. After investing millions in a hardware start-up, venture capitalists and other types of funders don’t want to take the risk of it quickly becoming obsolete.
Hardware Development and Crowdfunding
Crowdfunding is an alternative method of raising funds where the inventor reaches out to large numbers of people interested in the development of the project. Kickstarter and Indiegogo are two of the most successful crowdfunding organizations. Entrepreneurs choose from among several different categories to list their project for funding. It must be something that benefits and can be shared with others.
A detailed report released in August 2014 analyzed projects that raised a minimum of $100,000 on Kickstarter or Indiegogo. This covered a total of 443 new hardware projects that received a larger portion of their funding through crowdsourcing. The report indicated that venture capitalists had financed $321 million to hardware projects through a Kickstarter or Indiegogo campaign. However, start-ups that listed their funding proposal on Kickstarter received five times the amount of outside funding and investor-backed companies. One surprise finding from the report was that the amount of money a start-up raised on a crowdsourcing campaign had little impact on how much it obtained from venture capitalists.
Cons of Crowdsourcing
While crowdsourcing can provide funds for hardware start-ups that otherwise wouldn’t get off the ground, it definitely has some downfalls. First, it can be difficult to turn a profit. That is because people typically make the investment in order to receive a discount off the manufacturer’s suggested retail price. The initial funding a company receives all goes towards creating the product.
A second common challenge is that the company needs to invest in multiple components to make the final product. These range from connectors to electrical parts to molds. It’s common for the start-up organization to receive thousands of orders before ever building the product. That means it still needs to figure out how and where to order the supplies.
Underestimating the cost of building a prototype is yet another issue faced by entrepreneurs who rely on crowdfunding. They typically price the product at a loss just to get backing from financial partners. Shipping the actual product requires deep knowledge of the manufacturing process, especially these steps:
- Proof of concept
- Minimum viable product
- Engineering validation test
- Design validation test
- Production validation test
- Release to manufacturing
It’s also important to keep in mind that it may take more than one time through this cycle to be ready for the last step. Establishing a supply chain and visiting the organizations in person are critical to long-term success of the new product.