12 Ways to Fund Your Hardware Startup

Published on by John Teel

The odds are you are going to need some sort of outside funding at some point in order to get your product to market. If you are lucky enough to get your product to market without outside funding, you will surely require it to grow your company.

Nearly all hardware startups need outside funding either to develop the product or to scale up the company.

Fortunately, this doesn’t always mean giving away precious equity in your company or trying to get a nearly impossible bank loan.

In this two part article you’ll discover 12 ways to fund your hardware startup.

Some of these 12 funding options are most appropriate in the early pre-prototype stage, some are best for the mid-stage (post-prototype / pre-manufacturing), and finally some are only for once you are actively manufacturing and selling your product.

In this first part we’ll look at the early and mid-stage funding options, and then next week in part two we’ll cover later stage funding options.

Some of these funding options will likely be new to you. Others you will know about already, but you’ll get my perspective on how they relate specifically to hardware startups.

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

 

Self-Funding

The first method I’m going to talk about is self-funding. I know this one is kind of obvious but this is where we’re going to start, because this is where you are most likely going to have to start.

Although, rarely is self-funding enough on it’s own, it is usually the best option initially.

For self-funding, you need money to hire people to develop your prototype, or you need to have the skills to do it yourself, or some combination of those two.

Credit cards are the most common financing method used by self funded startups. They can be a good option, as long as you use them with caution.

You really need to have a good understanding of what it’s going to cost you to get your product to the point of being able to seek outside funding.

For example, if you have a credit limit of $4,000, but you need $10k to get to a presentable prototype, then you better have a plan to close that $6k gap.

You don’t want to just start spending money randomly, and you need to have a good idea of how much money you need to get to the next stage.

You’re never going to know for sure what every single thing will cost, but you need good estimates of your costs.

If you have engineering skills you can do a lot of the upfront development yourself. If you don’t have those skills, then you’re going to have to pay for engineering and early development which is never cheap.

Strive to get to the point of having a prototype that looks like and works like the final product. If you can get it to that point with your own engineering skills, you will save you a lot of money. You can always bring on other engineers later to clean up your design, after you have additional funding.

Co-Founders

The second strategy that we’re going to look at is to bring on co-founders. First of all, if you bring on a co-founder, they’re going to likely bring some money to the table.

If they become an equal partner or founder in the company, then they’re most likely going to invest money also. That can significantly lighten the financial load on a solo founder.

Perhaps more importantly, you need to find someone that will bring more to the table than just money. You need someone with the crucial skills you are missing.

In the beginning, there’s a lot of development work that needs to get done, and it is expensive to hire other people to do it all. If you and your co-founder can do this work, that’s going to be a huge savings.

If you’re not an engineer, and you have no idea how to design a new product, then a good strategy is to bring on a co-founder that has those particular skills.

Even if you are an engineer you likely won’t have all of the necessary skills to develop a new product. So you may want to bring on another engineer as a co-founder with complementary skills to your own.

Although in most cases, if you are an engineer, then I think you’re better off bringing on someone with marketing or sales expertise. That is the area most engineers need the most help.

It can be difficult to match up with someone who is a good fit, because being a co-founder with someone is really like a marriage. You’re going to be talking and working with them almost every day for many years, hopefully.

It’s really important that you find the right person because it can be a nightmare if you bring in the wrong person.

In most cases, it’s best if all co-founders have equal ownership in the company. So before giving away half of your company you better be sure they are the right choice.

Finally, not only should they bring money and skills to your startup, they need to also bring an equal level of excitement for the product and the mission. It’s important that all co-founders are equally driven to make the product succeed.

Friends and Family

The third option we’re going to look at is friends and family. Although, honestly, I’m not a big fan of this option. It can be an okay method of raising money but only for very small amounts in most cases.

Most importantly, you should only accept money from those that you know can afford to lose that money. Because startups are a very high risk investment. The odds are that they’re going to lose their money.

If they don’t, and everything is a success, then they could make a really high return on their investment, but the odds are they’re going to lose their money.

For instance, you don’t want grandma taking out a second mortgage on her house to pay for your startup!

If things don’t work out the way you want, it could really jeopardize your relationships with these people. Especially if grandma loses her house! That damage can last well beyond your startup, so tread lightly.

Professional investors understand the risk of investing in hardware startups. They understand the odds are they’re going to lose their money, and they expect it.

They invest in enough startups so they’ll at least get one that becomes a big win. Most will become losers. That one winner compensates for all the losers in their startup portfolio.

On the other hand, “normal” people don’t understand this, and most people can’t afford to lose thousands of dollars.

If someone in your family has considerable money, and you feel like they’re knowledgeable about investments and startups, then they may be a good funding option for you. But always be especially cautious with people you care most about.

You can have a horrible idea with almost no chance of success, and likely convince someone in your family or your friends to give you money. That can be dangerous because now you’ve got money and a really bad idea.

On the other hand, if you are able to convince a professional investor to invest in your company, that’s more meaningful in regards to how likely your product is to be a success.

It means that you found someone out there willing to put significant money down based on the product itself. Whereas, family and friends are going to mainly invest in you because they know you personally, which is many times a recipe for disaster.

Angel Investors

Angel investors are wealthy people that have extra money to invest in early stage startups. They typically understand the risk of investing in early startups.

A lot of times they want to be very involved in your startup. They may have connections and valuable experience to bring to your startup in addition to money.

Finding an angel investor can be a really huge boost for an early stage startup. Unfortunately, they’re not easy to find, unless you are lucky enough to have some connection to a wealthy individual.

Regardless of the type of professional investor, some level of personal connection to them is almost always required. Investors don’t give money to just random people that contact them. Instead they give money to people that were referred to them by people they already trust.

Everything in business always hinges on trust!

It would be ideal if the angel investor was from your specific industry because then all their connections are in that industry, but it’s not a requirement.

Angel investors are going to be just like any professional investor. They are investing in exchange for equity and will want a percentage of your company.

An angel investor will also typically invest much earlier than other types of professional investors such as venture capitalists.

An angel investor is typically going to help fund the pre-sales stage. Now, if you’ve had some small sales tests that’s even better. It increases your chances of getting an angel investor.

But angel investors are usually an option before the product is actually on the market and selling, and many times even before you have a working prototype.

Keep in mind that the earlier in the process they invest, the higher the risk. So they are going to want a higher percentage of your company in exchange for less money (meaning a low price per share).

It’s much easier to convince someone to invest, and you will give away less of your company, if you fund your own development to the point of having a prototype that looks and works like the final product.

AngelList is the most popular website for connecting with angel investors. But again, you will need a personal connection with an angel investor to have a real shot. Creating a profile on AngelList is never enough on its own.

Instead of reaching out to investors directly, reach out to those they are professionally connected to, and then work to get an introduction to the investor. LinkedIn is the best website for this purpose.

Crowdfunding

The fifth option we’re going to look at is crowdfunding. This method is, obviously, a primary goal of a lot of startups. Crowdfunding has gotten a lot of attention in recent years and I suspect everyone has heard of it.

It can be a really great method for raising funds but it has a lot of other advantages, in addition to money. Obviously, funding is the main reason you’re doing it, but just as important, if not more, is that crowdfunding provides proof that your product will sell.

Crowdfunding is about the best validation that you can have without actually having the product selling on the market.

However, crowdfunding requires that you already have a large online audience. You can’t just create a Kickstarter campaign and think that investors of any significant amount will find you.

You’re going to need an audience, likely of thousands of people, that are engaged with you and your mission. This audience is the catalyst to get the campaign started and get that snowball effect going.

Once you have that first round of investors, then it can spread and build from there.

Trying to run a crowdfunding campaign without an online audience simply will not work. Trust me, I tried it many years ago before I had any online audience and my campaign was like a ghost town.

One of my best tips for entrepreneurs is to start building your audience today because you’re going to need it in the future to kickstart your crowdfunding campaign.

In fact, you’ll need this audience for just about all of your marketing activities.

Make building an online audience a priority from day one. You should be developing your audience in parallel with developing your product. Both are necessary for success.

With crowdfunding, you do usually need to have a prototype. There are many horror stories of startups raising a lot of money on Kickstarter, promising a product, and then never being able to deliver.

There are so many unknowns between having an idea and delivering an actual product. You have to develop it, scale it, manufacture it, and deliver it, all of which can take a long time. Almost always much, much longer than you think.

Typically you need to have a prototype first, since it removes a lot of the unknowns in regards to development.

Nothing is more exciting than raising hundreds of thousands or million of dollars in a crowdfunding campaign. But that euphoria doesn’t last long before reality sets in. Now there’s a lot of pressure on you to deliver on a specific timeline.

Crowdfunding can also complicate things because you create so many equity holders in your company. There are ways to deal with this, but some professional investors can be turned off when there’s a lot of crowdfunded investors.

Lastly, it can also be really hard to recover if your campaign fails, especially if you were able to get significant publicity.

Startup Accelerators

Startup accelerators can be a good option, and are a great opportunity to learn all about hardware startups in addition to getting funding.

The main problem is they’re difficult to get into, and they’re very limited depending on your location. A few examples of startup accelerators include: Y-combinator, Techstars, AngelPad, and StartX.

Also check out The Seed Accelerator Rankings Project. They are a research entity, made up of academics, that ranks startup or seed accelerators using a variety of metrics. Their goal is to help guide entrepreneurs considering funding through a seed accelerator.

Product Contests

Next we’re going to look at entering your product in contests. This can be a great way to validate that your product is a good idea.

It’s not quite the same as validation through sales, but it’s still pretty affirming. If your product wins a contest that has significant funding behind it, that can be really beneficial, especially when you’re first starting.

It’s also really good marketing because you can leverage your contest win to get other people interested in potentially investing in your product.

No one wants to be the first person interested in a new product. If you win a contest, especially if it’s a contest where people vote, then you’ve got a crowd-sourced form of validation.

It can also be huge to get money or funding from winning a contest. There are lots of companies out there that hold contests for products at various times during the year.

When I was promoting my own product many years ago, I entered contests through Walmart and QVC.

You’ll need to search for the retailers and companies that relate to your exact product or industry, but there are definitely contests out there.

For example, if you have a pet product, look for contests specifically for pet and animal products. When searching for appropriate contests to enter Google is your best friend.

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 article we’ve now looked at 12 ways for you to finance and fund your startup.

The first seven presented are 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.

If you are developing a new electronic product get help from a team of experts and access to in-depth training courses in the Hardware Academy.

 
 

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