Mike Stachowiak

As the barriers to entry decrease, hardware start-ups are surging in number.  What use to take $10M, $25M, or $100+ million in capital investment to get off the ground 10 years ago can be accomplished for less than one million today, allowing smaller scale entrepreneurs (Roku, FitBit, LiveScribe, etc) to dip their toes in hardware waters once dominated by large corporations with enormous engineering and manufacturing operations.  The catalyst for this change is largely growth in the PC and cellphone industries, which have created an ecosystem of commodity parts suppliers, contract manufacturing shops, and industrial designers capable of cranking out almost anything a hardware entrepreneur can dream up (a detailed walk-through here).

As the cost of entry continues to drop and more hardware start-ups enter the fray with low capital requirements, the number of hardware deals available to angel investors is equally on the rise.  This begs the question, what should an angel investor, particularly one not accustom to hardware deals, be thinking about when evaluating an investment opportunity with a hardware start-up?

Hardware start-ups must get the device right the first time

This may be obvious but it’s incredibly important.  Like boxed software of the 90’s, hardware start-ups only get one shot at perfecting a product before it goes out the door.  The product can’t be upgraded once it’s in the hands of consumers, which is in stark contrast to web software that is continually iterated after launch.

With this is in mind, make sure what can be updated, such as device firmware, is upgradeable.  The device should easily connect to the internet to allow for easy firmware upgrades that can be pushed out as needed.

Teams experienced with hardware understand this well.  Teams with software experience often struggle.  Be on the lookout for both backgrounds.

Hardware start-ups rarely get it right the first time, plan accordingly

Like all start-ups, the likelihood the product is perfect the first time out the door is incredibly low.  Make sure the start-up has enough capital to get it wrong and iterate toward success.  Make sure the contractor agreements the company strikes avoid too much commitment to the initial design without room for modification.  The industrial designer should be available for design tweaks, the component suppliers open to order quantity changes, the manufacturing contractor open to changes in the assembly line.

Hardware start-ups are likely to have large capital requirements that will lead to future dilution

As much as it appears the hardware world is changing, hardware is still hardware, and large capital requirements can still present themselves.  If a hardware start-up intends to run the business entirely over the web, taking one customer order at a time, it may never have large capital requirements.  The start-up can hire an industrial designer to translate it’s device’s feature set into a function design for a small fee.  It can negotiate down the price of components from various vendors who are willing to supply them at scale without minimal order requirements.  It can contract a manufacturing shop in China to build an assembly line for it’s device, capable of producing thousands of units per week with on demand ordering, drop shipping, and customer service, all for a small capital investment and without minimum ordering requirements.  An angel investor eying this scenario and evaluating a hardware start-up may begin to believe the capital requirements are on par with software counterparts.

However, what happens to a hardware start-up when it becomes wildly successful?  What happens to a company, such as FitBit, when BestBuy decides they want 300,000 units in stores nation wide?  The start-up with apparently low capital requirements now needs a large capital infusion to meet inventory demand.  This requires a large institutional round that leads to heavy dilution for angel investors, dilution an investor in a software start-up may never see.