The world we used to live in — the one that revolved around using cheap money to pump up ARR — is gone.
It came to a screeching halt with rising interest rates, and it’s not on its way back anytime soon. VCs responded as VCs do: by quickly shifting from a “growth-at-all-costs” mindset to focusing on instant profitability while funding metrics shifted from just revenue and growth to including costs as well.
Since the beginning of Q2, a spur of companies, including hardware companies, have come out of the gate and started raising money. The Silicon Valley Bank (and, more recently, Free Republic Bank) debacle has been relatively short-lived, but, given the multiple rollercoasters the industry has been on, one has got to wonder where the goal posts are nowadays.
There’s no debate that the SaaS game has changed, and yet a consensus on Series A funding metrics for these companies hasn’t emerged. However, it is not too difficult to guess that it would be roughly around double the revenue bar at the same or lower cost. It’s a challenging proposition, but a clear and tangible goal to strive for — and one that cannot be applied to hardware companies without revenue in their early stages.
So how can a hardware company raise a Series A amidst yet another “new normal” in this post-low-interest-rate era?
Commit to having deployable hardware
Most hardware companies barely get their product to function — and can only do so using their own engineers and technicians. Hardware in this situation is not deployable on any meaningful scale.
At the Series A stage, VCs want to know that they can pump money into a product that will start going into the market. This does not mean that the product needs to be pitch-perfect; it just means it has to be sufficiently mature to function in a more unconstrained environment outside of the startup lab.
At the Series A stage, VCs want to know that they can pump money into a product that will start going into the market.
Use your ratio of engineering support per hardware as a metric for whether your product is deployable in the way it needs to be. If you have one engineer for the hardware piece you are deploying (not to be confused with non-engineer technical support personnel for customers), you do not have a deployable product.
Now, at a one-to-four ratio, the unit economics become more reasonable. As a stretch goal, you should target to get the human out of the loop entirely, but everything eventually boils down to unit economics.
If you’re hitting 70+% gross margin at a reasonable price, then you can afford to have more support — but it is going to be exceptionally difficult to maintain as an early-stage company with an immature product.
Show tangible proof of high-quality demand
Demand for hardware is fuzzy. On one hand, revenue is a meaningless indicator at the early stage since all companies want to pilot. On the other hand, hardware is very expensive in the absence of volume, while startup companies don’t have much capital. The number of pilots — and the corresponding revenue — is thus negligible and can’t be used as a simplified metric to gauge product-market fit the way SaaS companies use ARR.
Hardware companies used to get away with less tangible customer demand (usually in the form of pilots) and sometimes even letters of intent (LOI). Not anymore. VCs now demand very clear and tangible proof of customer demands.
The best-case scenario is a name-brand customer committing to a multiyear, seven-figure commercial contract. This is almost never going to happen, but it is good to break this milestone down to understand what it actually represents:
It proves the product’s value. Customers only sign such a contract after having a significant pilot and realizing values from the product. What you want is to prove the product’s value in a real-life setting. This may also come in the form of a scaleup plan. The more concrete the plan, the more it shows that demand is real — even with performance contingency.
It proves market demand. A marque customer is not just big; it is one that represents the market. The key is to find a customer that is a good representation, not just any large customer.
It proves your pricing power. This is how VCs will see how much value you can capture with your product and what your unit economics will be. It is understandable that you will have lower negotiation power at the start, but it is still important to demonstrate a decent ability to command a price in your pilot.
Hitting all three of these is the goal, but if you can’t, aim to hit two in a tangible way. And don’t settle for a verbal commitment on any of these. That won’t mean anything in this new normal.
Present a robust, diversified and cost-efficient supply chain
A long time ago — before the COVID-19 pandemic, the chip war and increasing tensions between the U.S. and China — the supply chain was an afterthought. Not anymore, though. The supply chain is top of mind for every hardware VC and a risk area they all pay very close attention to.
While it is not realistic to expect a pre-Series A company to have a fully built-out, diversified and qualified supply chain, it is realistic to expect that they have a plan and headcount to minimize this risk post-Series A. As a founder, you should have a clear idea of which key components need to be diversified after the raise and where to source them.
It is realistic, however, to expect a fully built out, cost-effective supply chain that minimizes COGS. Finding a cheap supplier is not hard. Finding a reliable, stable and reasonably priced one is a more difficult but achievable challenge.
As globalization comes to an end and geopolitics create shake up and instability, you should expect supply chain instability and address it before it happens. Ordering a surplus of critical supply (such as semiconductor-related components) is non-negotiable. While these supplies are generally not overly expensive, they can be in times of crisis. In today’s day and age, a marginal increase in stability should always trump a marginal increase in cost.
For these most critical components, do diligence on the supplier. Ask for customer references in a similar industry and size, and discern whether they are fit to serve your company today. It’s essential that you find one that can serve your company’s present and near-future needs. As a startup, you don’t need a supplier that values customers the size of Apple.