Putting the “hard” in hardware

I woke up in a cold sweat. Our camera supplier filed for bankruptcy – we were single sourced and GA was only a few months away. Our Director of Hardware calmly shrugged, “hardware has the word ‘hard’ in it for a reason.” Thoughts of managing supply chains, quality issues and CoGS models still give me the chills from my experience at Brontes and Sample6. At Brontes, we built a custom 3D scanner out of 27 custom lenses,  300 LEDs, and it took 18 months.

“Guts” of a Brontes scanner

Having seen a dramatic increase in the number of new hardware start-ups, I’ve been thinking about whether its easier today to do hardware?

Here’s why it’s gotten easier …

Today’s hardware companies focus less on the hardware itself and more on wrapping a software layer on top of often off-the-shelf hardware. Arduino (open source hardware prototyping) and things like Atom’s Express (a portfolio co) allow for rapid hardware experimentation.

Additionally, incubators aren’t just for web-heads anymore. Lemnos Labs in the Bay Area, New Lab in Brooklyn and Bolt in Boston, serve as great resources. In the past, I spent months searching for lab space and buying used equipment on Overstock.com. Today’s hardware start-ups begin product development on day one. Couple this with the rise of 3D printers like MakerBot and services like Shapeways, and it has become easier than ever to create prototypes and bring them to prospective customers, partners and investors. Crowdfunding sites like Indiegogo and Kickstarter provide a forum to take pre-orders and gauge demand, while generating cash flow even before the first article is made.

But it’s still hard …

You can’t start a hardware business in a Starbucks! Hardware requires more capital and takes longer to get to market. Hardware is often evaluated as much on look and feel as functionality or value. Thus, costly services like industrial design are  needed which  forces the trade-off between design and speed-to-market. Perhaps most importantly, many consumer hardware start-ups compete against the behemoth electronics brands and thus struggle to get distribution (or give up 30-40 points of margin for it).

Go for it …

We fund a fair number of hardware start-ups at Founder Collective. I love meeting hardware companies. My view is that hardware is a field where experience matters, so I encourage hardware entrepreneurs to get someone on board in some capactity with experience sourcing and managing vendors. Also, business model creativity is really important given the risk of commoditization. Consider models like renting or pay-per-use to create recurring revenue. Finally, bake as much functionality as possible in the software and enable over-the-air updates. Tesla is a great example of this (for ex. they’re changing the software to increase the height of the car to reduce the risk of the battery catching fire on highways).

Hardware start-ups are hard. But when you get it right, there’s nothing quite like bringing a new physical product to the world.

Yes, the goal posts keep moving

 

Goal post

It was one of my least favorite aspects of raising money. Time and time again I would ask VCs to articulate what metrics would be required to close funding. Inevitably I’d be left unsatisfied and wonder, “why does it feel like the goal posts keep moving?”

The answer has come into focus now that I’m on the venture side and it’s unsatisfying and simple. They are moving.

No such thing as hard metrics

Some investors might say I’d need to see “x” pre-orders for a hardware start-up, “y” downloads for a mobile app, and “z” revenue for an e-commerce company. Yet, such a formula is misleading to entrepreneurs (and bad investing). There are no precise metrics for getting funding, given how many intangibles go into building start-ups. Much like applying for college, kids with lower SAT scores get accepted to better schools and vice versa.

The venture market is more like the stock market than you think

We often think of the venture market in very different terms than the stock market. It feels like a cottage industry, more like the local real estate market than the broad securities exchange. The reality is that investor behavior is more similar than different. Macroeconomic factors impact the venture market – increasing stock values, economic data and even political conflict has an impact on capital raising for start-ups. Like the stock market, the venture market ebbs and flows.

Investors are influenced by their portfolio & deal flow

Let’s say you’re an e-commerce company doing $25K in monthly sales when you first sit down with a VC. The investor seems enthusiastic about the company. You come back a few months later doing 4x the sales looking to close the funding. Instead, the VC seems much less enthusiastic than the first meeting. What happened? It was a 4X!

Perhaps one of the e-commerce companies in the portfolio hit hard times and that colors the investor’s view. Or, maybe a new opportunity surfaced in the meantime that makes your company appear less attractive on a relative basis. None of these reasons are rational, but nonetheless impact the investment decision.

So what’s an entrepreneur to do?

One of my trusted mentors, Jeff Bussgang, said to me “VCs are in the extrapolation business.” It’s sage advice. Rather than focus on individual data points, the entrepreneur must generate data that demonstrates an upward trajectory of the business. Unfortunately, the x and y coordinates of these points are not obvious.

I discourage entrepreneurs from asking VCs to articulate metrics that will trigger funding. Instead, think about the risks of the business and identify the metrics that best address those risks. Don’t look to VCs to lay out a path for funding. Instead, knock down the risks you see and frame those metrics as the ones the prospective investor should care about.

Venture Debt: The third rail of venture financing

I’ve taken venture debt in all three of my start-ups. Additionally, many of our portfolio companies have taken some or are in the process of doing so. No doubt it’s a frothy market for debt. Nonetheless, when I polled others I respect, I heard everything from an unwillingess to comment  to outright dislike. Why is venture debt the third rail of venture financing?

A couple of years ago Fred Wilson wrote a post stating his view that debt is not appropriate for an early stage start-up. The primary argument was that venture-backed start-ups who have no current means of paying it off shouldn’t take on debt.

I, however, frequently encourage debt despite that most venture folks share Fred’s view. Some VCs argue that the start-up is riding on the VC as the financial backstop. This is true. In fact, most debt funds are only willing to finance companies backed by top tier, well-known funds. For the entrepreneur, this is another good reason for the start-up founder to get capital from such a fund! Secondly, the price of debt, often over 10%, takes into account this default risk. If the company defaults, ultimately the company reverts to the debt holders. These investors know what they’re getting into and have generally shown decent returns because most of their portfolio gets further equity capital.

Another counterargument to venture debt is that it can spook prospective investors in future rounds. There’s certainly merit to this argument. However, what the argument fails to consider is that founders need runway above all else. In my experience, the debt enabled my team to achieve the milestones we needed to raise more capital.

Investors are either buyers or sellers. Most investors put in equity dollars and want to see meaningful traction before further investment. When companies are going sideways or the trajectory isn’t obvious, debt is often the lowest cost way to extend runway. When I was a CEO/founder, I would ask my investors, will you put in money at the debt terms? The answer was always “no” and investors acquiesced.

Venture debt does have a dark side. When things start to go wrong, as one CEO said to me, debt can exacerbate decline. Servicing the debt can be costly to the burn and may make it harder to exit (typically on “soft landings”) because prospective acquirers don’t want to pay off the loan. That said, I’m a believer that the entrepreneur needs to “play to win” and as a result it’s beneficial for the CEO to get debt early, when it’s still possible to get it.

Venture debt is a case by case decision. By no means would I advocate it in all cases. The amount of debt borrowed, whether it’s drawn down immediately or not, and the terms are extremely important to consider when deciding to take it on.

 

The accelerator dilemma

Accelerators have become an amazing asset for the tech ecosystem. For start-up founders, however, picking an accelerator is like deciding to go to grad school. First you have to decide if its right for you, and then make sure you’ve picked to the right one. Just like grad school, attendance is not a guaranteed ticket to success. 

At Founder Collective we have invested in some really exciting companies that have gone through these programs. SeatGeek (DreamIt) and Contently (TechStars) are great examples. I expect us to continue to invest in accelerator graduates.

That said, prospective companies should be aware of the realities facing accelerator companies and how to maximize their likelihood for success. These include:

Investor fatigue

Recently, I’ve noticed fewer and fewer investors in attendance at Demo Days. Personally, I’ve found it difficult to attend many of them due to conflicts and the long time commitment (usually most of a day). Instead, I swing by the accelerator during the class “semester” to give a talk or hold office hours. I’ve heard some investors say they’re not stopping by a given accelerator, instead hoping to hear about buzzy companies through their network. Start-ups seeking capital should work pre-demo day to warm investors to the team and opportunity.

Challenging mentor recruitment

It’s getting harder for companies to sign-up great investor mentors. Investor fatigue is one reason, but also many investors have never invested in a company they’ve mentored. In the early days of TechStars, I mentored one company per class (e.g. StepOut and ThinkNear). These days I tell accelerator companies that I’m available to help out, but won’t mentor a single company. Industry or entrepreneur mentors are generally more valuable for companies at the early stage and thus, start-ups should focus their recruitment there.

Post Demo Day Thaw

Companies underestimate the pressure to raise capital before or immediately after Demo Day. There’s about a 60-day halo. Once the halo is gone, investors grow weary of companies that haven’t raised capital. There’s a negative signal that forms if a company is more than two months from a given Demo Day and has not secured capital. Early conversations with investors represent one hedge against this. More importantly, before applying to an accelerator founders should think hard about whether they expect to accomplish the requisite milestones during class to secure funding.

A positive sign for accelerator graduates

A growing number of investors are revisiting companies two or three classes removed from graduation.  Investors (and hopefully accelerator organizers) have realized that not all companies mature at the same pace. Some of the real gems, in fact, may have been out of the accelerator for a year or two. So, even for companies that don’t get funded right out of the gate, the future remains bright.  

Eyes way up in the sky, feet firmly planted on the ground

One of the hardest things for me as a start-up CEO was striking the balance between “selling” the big vision while remaining maniacally focused on the details. Sometimes it seemed as though everyone wanted to hear a different story – customers, employees, candidates, investors (especially those on opposite coasts!). My partner Eric put it best when he said, “keep your eyes way up to the sky, and your feet firmly planted on the ground.”  My colleague Gaurav points out that most founders give the “big picture” vision to external parties but do much less so internally. Founders often forget that teams need to be reminded of the broad company vision to keep morale high and turnover low.

Eyes way up in the sky

The startup CEO has to capture the imagination. I have found that most start-up meetings require “up in the sky” messaging. Like the coming attraction to a movie, the entrepreneur should confidently state a bold (but believable) statement of the future. The vision should be a couple of years out, not one, but not ten. Every employee or prospective investor should leave a meeting able to articulate the vision of the company.

When it comes to customer presentations and tradeshows, the same rules apply with a slight tweak in messaging to reflect their market knowledge. At Brontes, we started sales pitches by saying “imagine a day when dentistry is digitized like music or photography.” Potential customers (dentists) would nod in agreement. It was a hard vision to deny and we would spend the rest of the pitch addressing why we’d be the ones to do it.

Feet firmly planted on the ground

The details support the overall vision. Once you’ve compelled the audience by describing a future state, the key is to convince that you have the plan and ability to get there.  Those of us that have started ventures know how hard it is and that most businesses are built brick by brick.

Early stage company CEOs have to shown deep comprehension and appreciation of the product and tech. CEOs should be conversant on what technology platform a given product is built on, aware of the development schedule (and how far ahead/behind the project is) and he/she must be able to demo the product. At Sample6, I spent time in the lab trying to learn how a competitive product worked. I spent time at customer sites. I’d come back with real-world anecdotes about why the product needed to be made easier to use or ideas on how to pitch it differently. Most importantly, the quickest way to lose credibility with an engineering team is to seem removed from details or unappreciative of the complexity of their work. This is heightened when times are tough.

The start-up CEO is both a general and field marshall. The challenge is balancing these two roles – internally and externally.

Handshake.com meets 2013

In 1998, I co-founded Handshake.com, a marketplace that connected buyers and sellers for all sorts of services – from carpet cleaners to auto repair shops. Since Handshake came and went with the go-go days of the late 90s, I’ve spent a lot of time thinking about the mechanics of such marketplaces. Today’s online service marketplaces have been generally more successful than our foray. Recently, I tried a few to help with the construction of Founder Collective’s new office at 27th St in NYC.

Original handshake team going live in Dec, 1999

Original handshake team going live in Dec, 1999

First, I used TheSweeten, a site that matches projects with contractors/architects.  I posted images of our current space and a crude mock-up of the build-out I envisioned. I received 3 bids from vetted contractors and ultimately selected one of them. We then needed furniture moved from our Cambridge office, so I hired a Taskrabbit to bring it to NYC. Once the build-out was complete, I used Handybook to schedule and coordinate a plumber to fix an old water purifier and a handyman to assemble IKEA furniture. And last and most importantly, we hosted our kick-off party with catering from Kitchensurfing (a portfolio company). These services aren’t yet one-click and done, but they have come a long way in making it easier to coordinate moves, construction, catering and transportation.

Last week, at an ERA event, I was asked to share my lessons learned about these types of marketplaces. Here’s what I said:

1)   Pick a vertical, not many – One of the mistakes we made at Handshake was that we offered every service we could find in the yellow pages. However, we spent way too much time and money marketing the idea of an online service marketplace. If you’re trying to create a national brand, it’s hard enough to get consumers to keep you in mind for a particular service, let alone many.

2)   Control the money flow Much of the frustration around hiring service providers stems from challenges making payments(many want cash or don’t accept credit cards), whether to pay a deposit, and how much to tip. Additionally, if the marketplace doesn’t hold the money, it is far too easy for the service provider and customer to work around the system, and avoid fees or commission. If the marketplace isn’t stepping into the money flow, it’s likely because it’s not creating enough value for both customer and supplier.

3)   Delight both customer and supplier (but hold each accountable). Uber (also a portfolio company) does a fantastic job of this. The app knows where I am and where the cars are. Its just two clicks to call a car, my credit card is on file and there’s no tipping. But I’m most impressed (and surprised) by the driver’s reactions. They love the fact that they can rate me (1 to 5 stars) … the customer!

For the full Handshake story, click here.

The Business Plan Competition Deconstructed

Nowadays, nearly every school runs one. Last week I judged the NYU Business Plan competition with Fred Wilson, Dave Tisch, David Aronoff and Geoff Smith. It was an exciting event packed with four great finalists. Having sat on both sides of such competitions, I think their purpose is often misunderstood.

Business plan competitions are imperfect and artificial. By their very nature, they are academic exercises.  Sure, the goal is ultimately to start a business but the reality is that this is the exception not the rule. In my experience, at Brontes, we started a business after coming in second at the MIT $50K, however, it was based on a completely different business plan.

The competitions are great forcing mechanisms for bringing teams together around a business thesis. They place deadlines in submitting executive summaries, slide decks and, still, the nearly extinct longform business plan. Most entrepreneurial teams need some amount of structure, and for this, the competitions are useful. They encourage the team to debate ideas like which market to focus on, whom will be named CEO, CTO and how to finance the business. These are worthwhile conversations and are educational whether or not the company is founded.

The competitions are a great way for a team to build its network. Most competitions attract a fairly prominent set of faculty, industry folks and venture capitalists (myself excluded!). The feedback I heard on the panel at NYU last week was constructive and simulated the entrepreneur’s experience pitching his/her business to a VC. The savvy entrepreneur will keep track of the judges as a way back in the door for future conversations.

Despite these benefits, many participants have unreasonable expectations about the competition. The prize money may woo some, frequently academic-minded teams, in the way that government grants are viewed as easy money (but isn’t really). None of these competitions provide enough prize money to fund a venture at any level. Additionally, often the prizes have strings attached. For example, many offer free legal services for a period of time. In those cases the services are great, until the founding team feels locked into a firm or partner they don’t like.

Most importantly, the winners of the competition are not branded as future IPOs in the minds of investors. Similarly, those that don’t win are not destined to fail. My experience at both Brontes and Sample6 is that the results of a competition never come up in any VC discussions.

The most valuable part is getting the team together, practicing the pitch and getting feedback from judges. The competition is a low risk practice run for crafting a business pitch. Used for this purpose, it’s a valuable exercise.