How to Fund Your Electronic Hardware Startup

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It’s an expensive process developing and marketing a new physical product, especially if your product is complex.

Unless you have tens of thousands of dollars that you can throw into it, you’re most likely going to need to get creative when it comes to funding your new startup.

NOTE: If you're serious about developing a new electronic hardware product then download our free cheat sheets - 15 Steps to Develop Your Electronic Product and Summary of the Costs to Develop Your Electronic Product.

Funding Development

Unless you’re an engineer, you’ll need to outsource most of the development to an experienced engineer, or two.  That being said, it’s always best if you can take your product’s development as far as possible on your own.  If you’re not technical, then you should probably find someone technical to be your co-founder!

Assuming your product has electronics, you’ll need an electronics design engineer. If your product has moving parts then you’ll probably need a mechanical engineer.

Lastly, you will need a 3D modeling expert or an industrial designer to develop the custom plastic pieces for your product such as the case holding everything together.

You need to budget for multiple prototype iterations to get your product ready. My favorite example is Dyson vacuum cleaners. Its founder, James Dyson, says it took 15 years and 5,127 prototypes before he got his first vacuum cleaner ready for market! Okay, that’s probably taking it too far, and don’t make the mistake of striving for perfection.

How is a struggling entrepreneur supposed to fund all of these development costs? There are several strategies available to you.

Crowdfunding

The most popular strategy right now is raising money through crowdfunding campaigns on websites like Kickstarter. The main issue I had with crowdfunding is that it requires you to have a large social network, which I didn’t have when I tested it.

That’s why I always recommend that you begin building your audience as soon as possible.  Not building an online audience for my own product from the very beginning is one of my biggest regrets.

Another potential issue with crowdfunding is having hundreds or thousands of small investors.  This will complicate things later on if you ever decide to bring on professional investors.

That being said, crowdfunding is one of the best things to every happen for hardware startups.  You get capital and market feedback all in one!  If your crowdfunding campaign is a runaway success then that probably means your product will also be a success.  Assuming, of course, you can get it developed, manufactured and shipped.

Manufacturer Financing

My favorite strategy is to get a manufacturing partner to help fund the development. If you can find a manufacturer that produces similar products, and if they aren’t at capacity, you may negotiate a deal with them to pay some of the development.

In my experience this becomes significantly easier if you at least have a crude prototype, some solid market research, and better yet early interest from a big customer.

Incubator and Accelerator Programs

Another option you might want to consider is going through a hardware startup accelerator or incubator program.  Not only do you get funding but you also get the guidance of a full team of startup experts.

Incubators are typically for entrepreneurs still at the very early stages of innovation, whereas accelerator programs are for startups a bit further along in their product’s development cycle.

One of the more well known accelerator programs that works with both software and hardware startups is Y Combinator.  Some other accelerators, or seed investors, that focus specifically on hardware startups are HAX Accelerator, Lemnos Labs, and Bolt.

The advantages of an accelerator program are the funding and the guidance from a team of experienced advisers who have a vested interest in your success.  The downsides are they’ll want a good chunk of your company, and will require you to relocate to their location usually for at least for a few months (or perhaps permanently).

Funding Manufacturing

Most products require at least two plastic parts (for example, the front and back side of a case) and each part requires its own separate (pricey) high pressure injection mold.

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How does an entrepreneur pay for these molds? Once again a manufacturing partner can come to the rescue. You may be able to get a manufacturer to amortize the cost of your molds. This means they will spread out the mold cost over a certain number of units.

For example, if your molds cost $10k then the manufacturer may amortize this cost over the first 10k units. So you’ll pay $1 extra per unit for the first 10k units.

How do you find a manufacturer willing to invest in your product? I found a list of manufacturers online that produced similar products to mine. Only look at manufacturers with all of the necessary equipment already in-house.

I suggest you focus on manufacturers based in the U.S. but with factories in Asia. This provides several advantages including better customer service and a lower risk of having your product stolen.

Several of the manufacturers I contacted expressed interest in my product but one stood out as the best partner for me. A few months later one of their executives flew to Homer, Alaska (where I lived at the time) to finalize our agreement.

If you, or your co-founder, aren’t a design engineer, then development costs are going to be one of your biggest expenses.

Once you finish developing your product then you can look forward to all of the expenses for setting up manufacturing. 3D printing is great for prototyping low quantities but for real production you need to upgrade to injection molding.

Most of this cost is for the high-pressure injection molds that will be needed for creating your product’s custom plastic case in production. These molds can be really expensive especially when designed for high volume production like making millions of parts.

The costs of these injection molds are a huge roadblock for any entrepreneur developing a product with custom plastic (or metal) pieces.

Surprisingly to most, the path from prototype to high volume production for the electronics is much simpler and less costly, than it is for the plastic case.

Of course, most entrepreneurs don’t have a couple hundred grand to spend, so you have to look at alternatives.

What about bank loans, you ask? Absolutely forget about that! It doesn’t happen! Banks lend money to established low-risk companies, not startups.

Your best bet is to take the product as far as you can without any outside financing. Once you’ve at least proven there is a market, and that you know how to get the product developed, then you can pursue what I consider the two best startup financing options out there – crowdfunding and manufacturers!

Funding Inventory

In regards to inventory, the major issue is that typically a manufacturer expects you to make payment upfront for any product that they manufacture. However, if you sell to U.S. retailers they expect to pay you 30-90 days after they receive their merchandise.

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The auto part industry (AutoZone, etc.) is the worst and they expect to pay you one year after they receive the order! Crazy, but true.

This means the entrepreneur has to finance the order, then wait months for payment. That’s not an strategy that will work for most entrepreneurs.

Everyone hates inventory! Inventory is one of the main reasons investors almost always prefer software startups.

Inventory is both expensive and risky. It also significantly slows down any product improvements that you can make. Many a startup have died because they purchased inventory for a product they couldn’t sell.

But assuming your product sells perfectly, your biggest issue is that normally a manufacturer wants you to pay upfront for any product they produce.

However, if you sell your product to retail stores in the U.S. then they will want you to pay 30-90 days AFTER they receive the order.

So all of this means that you’ll need to finance any inventory you purchase for about 4-6 months. That means if you get some big million dollar order then you’ll need to have about $500,000 to invest.

This assumes you sell product for double your cost (50% gross margin), which is a pretty standard goal.

Once again a great manufacturing partner can come to the rescue. If you do things right you may be able to get them to be willing to provide you payment terms of 90 days.

This is definitely not very common because they are taking a huge risk with a new company, but if they really believe in you and your product then it is possible. I was able to get a manufacturer to agree to these terms so you can too.

These extended terms will now allow you to get paid by your customers BEFORE you have to pay the manufacturer. This method requires no financial investment on your part!

However, an even better solution is to only sell to customers that don’t expect you to have inventory in stock, and who pay immediately.

Surprisingly, the best customers to meet this criteria are foreign ones. For example, in the U.S. most retail stores will expect you to fill orders within a couple of weeks, and they won’t pay you for at least 30 days. They will also tend to order small amounts at a time since they know they can get more from you quickly.

However, if you instead find a customer in Australia or Europe, they won’t expect you to have carry inventory in their country. They, or their import supplier, will order directly from your Asian factory a quantity large enough to make it worthwhile to ship that far.

And the best part is they will expect to pay you at the time it ships from your factory.

This same strategy can also be implemented domestically on a limited scale by only targeting the super huge retailers.

For example, Wal-Mart or Home Depot won’t expect you to have enough product in stock to supply them, so they will also place an import order just like an international customer.

For import orders, instead of paying 30-90 days after receiving the order, international customers will pay you immediately upon shipping. So with this strategy you just need a manufacturer that will allow you to pay at the time of shipping. This is much easier than finding one that will give you 90 days to pay.

If you get a large order from an established company you can use something called purchase order (PO) financing to pay for production. For PO financing it’s the credit rating of the customer that matters and not yours, so for most startups this is a better option than a bank loan.

If you are able to fund the manufacturing (or have a manufacturer that has agreed to allow payment at time of shipping), but simply can’t wait the 30-90 days for your customer to pay you, then invoice factoring may be an good option.

As with PO financing it’s the credit rating of the customer that matters with invoice factoring. Once you invoice your customer, instead of waiting for them to pay, you sell the invoice to a factoring company. They pay you immediately, then they deal with collecting payment from your customer.

Invoice factoring is cheaper and easier to get than PO financing. This is because the lender’s risk is much greater with PO financing since you’ve not even produced the order at this point.

So with PO financing the lender has the additional risk that you won’t be able to produce the order correctly. With startups this risk is usually much greater than the risk of having a major company not pay an invoice, so PO financing is much harder to get and will cost you a higher interest rate than invoice factoring.

Creating a new physical product, especially a complex tech product, is by no means a cheap, or easy, process. This is why so many entrepreneurs focus on software products.  Software products are many times easier and cheaper to bring to market.

But the eventual payoff can be bigger for hardware startups, and in fact there is a hardware renaissance happening in the startup community.

NOTE: If you're serious about developing a new electronic hardware product then download our free cheat sheets - 15 Steps to Develop Your Electronic Product and Summary of the Costs to Develop Your Electronic Product.

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