Learn what a startup should know about investments in new hardware product development.
There is a new reality emerging in venture investments, and it’s not virtual or augmented – it’s start-ups building real products. Dr. Peter Dudin, CBDO of EnCata, talks about a new trend favouring investments in IoT and other hardware start-ups.
Today, IoT-connected hardware devices that use core scientific technologies and fairly complex built-in software are one example of the trend in favour of hardware. Mobile applications and services are no longer in fashion, with the competition high and barriers to market entry low. This new trend has deep-tech start-ups implementing fundamental IP in hardware devices as the main competitive advantage. Deep-tech hardware startups are about scientists and hardware and software engineers teaming up to renew old industries and change market rules. Such start-up teams are able to resolve R&D problems, pivot when needed, and transition from lab-scale technology to mass production and technology-as-a-service (TaaS) business models.
Deep-tech startups are inherently hardware-focused, which is not surprising since scientific advances are usually embodied in new hardware products or advanced materials. Many projects, however, do not reach the market because scientists and developers are not always well-versed entrepreneurs who can choose the right new product development strategy. Moreover, the process of raising funds to transition a hardware product from R&D to a commercial scale product with stable revenue often becomes an intractable challenge, otherwise called the “valley of death”. Unfortunately, today, the venture capital model does not align well with the capital-intensive nature of hardware investments.
What you need to know about investments in deep-tech startups
For a new product development process to become more clear, any startup must realize what investments are and what types they can be divided into. Typically, there are 3 main investment types:
A start-up at the pre-seed stage has only a laboratory technology or concept. Investments are necessary to finish R&D and demonstrate the technology at a lab scale. Professional investors rarely invest at this stage. Therefore, a start-up should count on friends and family, savings, grants, and angel investors, who are very difficult to find at this point. Pre-seed investments are typically in the range of $150,000–300,000.
Here the start-up’s focus is on engineering a pre-production prototype with working software, filing patents to protect core technologies, and launching limited batch production. While some start-ups can use crowdfunding, such as Kickstarter and Indiegogo, to demonstrate first sales and test market demand, crowdfunding is typically not available for deep-tech start-ups because of their focus on industrial applications and B2B solutions, which are capital-intensive.
Start-ups should be actively searching for professional investors at the seed stage who recognise the new trend in favour of hardware investments. Hubs exist in San Francisco, New York, Boston, Shenzhen, Berlin and other locations with investors willing to support hardware and deep-tech start-ups. Venture investors commonly provide funding ranging from $1-5 million at the seed stage. Success is measured by finding the right product market fit and achieving pre-market launch sales. If all goes well, start-ups begin to hire additional staff to meet growing customer demand and ready their product for commercial scale production and sales.
Scaling stage – series A and B rounds
At this stage, the start-up has achieved a market launch but needs to invest substantially more capital in marketing, sales and inventory to meet customer demand. Venture capital firms, such as Sequoia Capital, NEA, and emerging IP capital firms with a model focused on hardware investments (Cote Capital) are engaged in investing in scaling start-ups at this point.
Alternatively, large corporations like Google, IBM, Walmart, Nestlé, Facebook, or Boeing may decide to buy a deep-tech start-up if they have a strategic need for the start-up's intellectual property and its team's extensive experience. Why do they prefer M&A over in-house development? Low appetite for risk among C-suite managers for the uncertainty present in developing new technologies is one reason. Another motivation is the size of the market opportunity a start-up offers for the acquirer’s well-established sales and distribution network.
Such M&A deals (at seed and series A or B rounds) are typically in the range of $10-80 million, with the internal development cost reaching a lower boundary in value and the perceived market opportunity and timing advantage over competitors coming to an upper boundary.
How to find a good start-up investment? This question is both complex and simple. We typically consider 4 main factors:
• A professional team
Competent specialists who have every confidence in the company, display good character – high integrity, faith, resilience, creativity – and have the emotional intelligence to see challenges as opportunity, not roadblocks. Being an entrepreneur is an epic journey.
• Core technology
Is the IP really proven, working and a genuine competitive advantage?
• Market validation
The product should solve an existing problem in a large addressable market or make a business and/or industrial process more efficient. Also, the start-up must demonstrate the product’s market fit either through customer pilots or first sales.
Speaking about promising business models, one should have a “moat” principle in mind, which is having a competitive IP edge for long enough to deliver an appropriate return on investment. Examples include:
• Subscription-based models where start-ups connect clients to their ecosystem
This business model is extremely favourable to investors because it offers a more predictable future. Whether you are a new software-based platform, or a satellite-launch service, customers often persist for years.
• Unique technology
Possessing IP that no one else has provides a timing advantage over market competitors (remember, R&D is a long and expensive process).
With the new trend favoring deep-tech start-ups, we are witnessing a fundamental shift in how we invest in emerging companies, which takes us full circle from historical trends preferring hardware over software, and back again to hardware. This time, it’s dedicated applications as the cost of hardware has lowered to enable deep-tech start-ups to take advantage of the higher performance inherent in application-specific hardware. With deep-tech start-ups starting to commercialize science in hardware devices, it’s getting real again!
To find out more about IP capital please visit https://cotecapital.com/