12 Ways to Fund Your Hardware Startup – Part 2

Published on by John Teel

In part one of this two part article, we looked at seven strategies to raise money during the early to mid stages of your startup.

This included self-funding, bringing on co-founders, borrowing from friends and family, angel investors, crowdfunding, startup accelerators, and new product contests.

Now, in part two we’re going to look at some of the later stage methods of funding your hardware startup.

NOTE: This is a long, very detailed article so here's a free PDF version of it for easy reading and future reference.

Partner with a Manufacturer

If you are able to partner with a manufacturer, this can help you in several ways.

First of all, they can offer what’s called amortization, which operates like an interest-free loan. They will charge you a fixed dollar amount added to each unit that’s manufactured, until you have paid them back.

Let’s say your manufacturer invests $100,000 in your product. Then, they charge you one extra dollar per unit for the first 100,000 units that they manufacture for you. That’s how you pay them back.

It’s a great way to get money without having to give away any equity in your company, or having to pay interest.

I used this method mainly to fund the cost of the high-pressure injection molds I needed to manufacture my product. They cost over $100,000. Don’t worry, lower volume production injection molds are not nearly this expensive.

While I used my manufacturer to cover the cost of molds, you can also try to convince a manufacturer to invest earlier in your product.

When I approached my manufacturing partner, I had a fairly late stage prototype. If you are in an earlier stage of the development process, then this amortization could be used to fund some of your development costs.

For example, if the manufacturer has an engineering department that isn’t operating at full capacity, they may be willing to help you in exchange for an exclusive manufacturing agreement. This could be in addition to any amortization that they’ve offered.

In my case, I was able to utilize my manufacturer’s engineering department. They helped me finalize my design and prepare it for injection molded mass production.

Although amortization and engineering support are very helpful, perhaps the most important benefit they can offer you is favorable payment terms.

Instead of requiring that you pay for an order upfront, as is usually the case, a manufacturer could offer you payment terms that allows you to ideally pay them after your customer pays you. That way you never have to use your own money to cover the cost of manufacturing your inventory.

In order to account for manufacturing time, shipping time, and typical customer pay times, you’ll likely need at least 90 days in order to collect money from your customer in order to pay back your manufacturer.

That’s not an easy thing to negotiate with a manufacturer by any means, but it is possible. This will open up more opportunities for growth because it eliminates the main bottleneck with growing a hardware startup – cash flow.

Even if you can’t get them to give you 90 days to pay, if they’ll let you pay at shipping instead of upfront that will be hugely beneficial for you.

Amortization, engineering support, and favorable payment terms are the three key ways a manufacturing partner can invest in your startup.

Partner with a Customer

Another beneficial funding arrangement is with a customer. Again, you want to get favorable payment terms, but now you are on the other side of the equation.

Typically, a retail customer is going to want to pay you, at the earliest, 30 days after they get their order. But some retailers take 60 days, and even 90 days is fairly common too.

Some industries, like auto supply chains, can have payment terms of one whole year! That means you ship your product to them, and they don’t pay you until a year later.

This is basically using you to finance their company. Now you have become the supplier providing financing.

If you can get a customer’s payment terms shortened, that’s almost like having them lend you money. Do whatever you can to shorten the amount of time before your retailers have to pay you.

If you can get them to pay upfront for the order, that would be ideal. But that’s exceptionally rare. In general, you can negotiate with your manufacturer a lot more than with your customers. A manufacturing partner will likely need your business more than any of your customers.

Larger companies have very set procedures on when they’ll pay you, and they don’t have any motivation to alter that for you.

The one thing they can do to help you is to give you a purchase order. Having the purchase order in hand can be financially beneficial, because you can then leverage it to get other types of financing.

Purchase Order (PO) Financing

Once you get a purchase order from an established company, you can use that to obtain purchase order financing.

Purchase order financing is a short-term financing option. It provides you the capital to pay your suppliers upfront, as long as you have a verified purchase order.

What’s great is the purchase order financing company looks at the customer’s credit rating, not yours, in order to approve the loan.

If you get an order from, let’s just say Walmart, the lender is going to use Walmart’s credit rating. Obviously, a large company is going to have a good credit rating. This means it’s going to be a really easy way for you to essentially get a loan.

You likely won’t get turned down even if you’ve got less than stellar credit. Also, there’s no equity exchanged for this financing, so you don’t give away any of your company. You’re just paying an interest rate.

With PO financing you get the loan before you manufacture the product. So, if you’re working with a manufacturer that requires you pay them upfront, this would be a way to make that happen.

The main downside with PO financing is that the finance company will want to collect payment from your customer. They’re going to collect the payment, take off their percentage, and then give you the rest.

Technically, there’s not a problem with that. Except now, instead of you interfacing with your customer, a third party is coming in and collecting money. This tells your customer that you aren’t in a solid financial position. That may not be the image you want to convey.

If your customer understands that you’re just a start-up and that you’re using PO financing, then they’ll understand why there’s going to be a third party collecting the payment. Just be aware of that as a potential issue.

PO financing is considered a higher risk loan. Even though the loan is based on the credit rating of the customer, and you have the purchase order, the risk becomes whether or not you can deliver.

What if they give you the money and you are unable to manufacture and deliver the product to the customer as agreed upon? That is the biggest risk for the PO financing company.

Invoice Factoring

The next method we’re going to look at is invoice factoring, which is lower risk than PO financing for the lender.

It’s a safer bet because invoice factoring happens after you’ve manufactured the product and you’ve shipped it to the customer. That’s when you’ll generate your invoice to bill the customer.

Now your customer is legally bound to pay that invoice. This is called account receivables. It’s almost as good as money, if your customer is a trusted company.

You can then sell that invoice. Instead of having to wait for the customer to pay you in 30 or 60 days, you’ll get the money right away.

It’s a lower risk for the lender, so it’s also a lower interest rate. It has the same downside as PO financing – a third party is going to collect the money from your customer.

You may wish to use both PO financing and invoice factoring together. In this case you start with PO financing but then once you invoice your customer you refinance the loan as invoice factoring with a lower interest rate.

Venture Capital

The final option we will discuss is venture capital. These are large, professional investment companies that invest in later-stage startups.

When seeking VC funding, you should already have a completed product that’s on the market and selling well.

A venture capitalist could be an option when you need financing to grow faster, if you want hyper-fast growth for your startup. Beware though that hyper-fast growth has it’s own pitfalls, and slow and steady growth is typically the best route.

First, try to optimize your customer payment terms and your manufacturer payment terms. Next, consider PO financing and invoice factoring to help you grow your startup.

Use these methods before going the venture capital route. If these are still not sufficient for the growth rate that you need, then you can pursue venture capital.

Any venture capitalists are going to want significant control in your company. You’re going to have bosses that want constant updates and may want to pull your company in a different direction than you do.

This is going to add a lot of stress for the founders. But, if you already have significant sales and need cash to grow, then venture capitalist funding might make sense.

Just be careful because, and I’ve personally known this to happen, you may find yourself booted out of your own startup if you give away majority control.

Remember, way back in 1985 when Steve Jobs got booted from Apple? That could happen to you too. You would still be an investor, but you would have no control over the direction of the company.

If it’s a billion-dollar company, sure, be happy with a couple of percent of that! A small piece of a huge pie can be a lot better than a big piece out of a little pie.

But the danger is, you end up giving away control of the company and you could get kicked out. And even worse, the new leadership could take the company in the wrong direction, and you also lose your investment.

Additionally, many companies find themselves trapped in a never ending loop of funding rounds. If you have venture capital and you use all that money, you will need to get a second round of venture capital, followed by a third, and on and on.

You may find yourself always raising money instead of actually running a hardware company.

Conclusion

In this two part series we’ve now looked at 12 ways for you to finance and fund your startup.

The first seven presented in part one were mainly for early-stage funding options, and the last five are for the later stages where you are successfully selling the product.

In the end, always prioritize funding methods that don’t require you to give away precious equity in your company, at least for as long as possible.

The key to success is knowledge of the obstacles that lie in your path and a realistic plan on how to overcome those obstacles. Helping you accomplish this is the goal of the Predictable Hardware Report.

If you need affordable coaching, training, and support to help bring your new electronic hardware product to market then be sure to check out the Hardware Academy program.

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