Raising venture capital: The pre-fundraising checklist

“Hardware is hard” is one of the old adages you hear from stuffy venture capitalists gathered in a Palo Alto coffee store. And it is hard. As a hardware startup, you require significantly more capital to scale than a typical venture-backed software company. You operate at lower margins, and your time to market is usually more significant. 

But as a deep tech investor, I’ve spent my entire career obsessed with unsexy industries, and I believe that hardware investment represents one of the greatest current contrarian theses in venture capital. I’m thrilled to partner with the team at informal, who are similarly aligned in breaking down barriers for hardware startups, to bring you this guide on how to fundraise in venture capital for your hardware startup.

Sometimes VCs don’t quite understand the hardware they’re investing in.

For the first part of this series, we talk about the information you need and the prep work you should do before fundraising as a hardware startup. Chiefly, not every startup is meant for venture capital, and even if you’re meant for venture capital, you still need to go through a thorough process to become “VC ready.” 

A disclaimer before we start: Every business is different. Consumer hardware is very different from a launch company or a recycling robotics company. We try to generalize the advice, but every fundraise is bespoke, and strategies that work for others may or may not work for you. The important advice for fundraising — as for all parts of startup life — is to fail fast, fail often, and fix it. As Elon Musk says, “Make the requirements less dumb, delete the part, simplify, accelerate cycle, automate.” Fundraising isn’t different from engineering in that way. 

What do VCs look for in hardware investments?

The important understanding is that most VCs investing in hardware startups aren’t engineers: They come from predominantly standard investment backgrounds, typically SaaS (software as a service) or banking. And oftentimes they look to fit hardware investments into similar molds. Your job is to succeed within that — in essence, demonstrate that you have a product that will scale exponentially by infusing it with capital, and that you’re the right person to build that business and to continue raising more capital.

Robotic factories are the future, but many VCs don’t understand how to get there.

With hardware businesses, you’re at an immediate disadvantage. Hardware businesses by definition require capital expenses (CapEx) spend. In venture capital, the more money the company raises, the worse it is for the early investors (unless the valuations go way up). 

By requiring CapEx in addition to operating expenses (OpEx), hardware startups inherently require more capital in total, or at least that’s what most VCs assume. The products are also slower to market, which affects a VC’s internalized rate of return (IRR), one of the most important numbers they focus on. When VCs invest in hardware, they want to see business models that have a great enough scale to overcome the additional capital and time required to balance the return profile with that of a software investment.

 So structurally, hardware startups are at a disadvantage. But additionally, many hardware founders often struggle with storytelling. This is to be expected — your typical hardware founder comes from a technical background, and they don’t usually teach presentation skills in a thermodynamics class. The issue this presents is that technical founders must communicate with (largely) nontechnical VCs. Easier said than done. 

Oftentimes I recommend pitch coaching or bringing on a nontechnical cofounder to handle pitching. CEO is a highly sales-related job, and even if you’re the founder and majority shareholder, you may be a better fit to be the CTO than the CEO. There have been several instances where I’ve seen a CEO step into the CTO role after raising initial rounds, and those are some of the best performing and smartest operators I’ve seen. Know your own weaknesses and be honest with yourself in that evaluation. 

Should you even raise venture capital?

This raises an important question that you must be honest with yourself about: Is your business actually a fit for the venture capital business model? You can have a billion-dollar business idea that doesn’t fit venture capital. That isn’t to say this is an unwinnable situation, even some of those businesses raise VC, but think of it as the Star Trek Kobayashi Maru, the unwinnable scenario. Sometimes non-VC businesses raise VC dollars (Captain Kirk beat the Kobayashi Maru), but those are usually edge cases (Kirk cheated).

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In short, venture capital is meant for scalable companies with technology and market risk. It’s important to delineate between a company and product in this space. Many successful medical devices are products. Roomba, despite some ability to launch variations, is a product, not a company. Products can raise venture capital, but it’s a hard path with a significantly lower probability of success. Hardware companies are Apple, Bosch, Tesla — all companies with suites of differentiated products built on a single core competency. It’s easier to sell the vision here — the 30x returns that venture capitalists need to generate.

Some alternatives to VC include but are not limited to government funding, project finance, small business loans, angel/family office financing, crowdfunding, product pre-sales, or corporate partnership. All of these have their own strengths and weaknesses but could be a better fit for your business than an endless cycle of venture capital pitches when you’re not a fit for the market. 

How to know if you’re VC-ready

Are you toooo early?

Something that a good friend of mine, Darrel Frater, talks about a lot is the concept of being “VC ready.” There are obvious parts to this: You need to be working on the startup full-time. You need a pitch deck. You need to practice the pitch and rehearse it. But there are a lot of more intangibles. A quick list:

• You need to consider your traction, and if that correlates to the implied valuation (round size/0.25) that you’re raising at.
• You need to vet how your team presents on calls, and how that tells the story of building a company.
• And, depending on the stage, you need to have documentation ready for external due diligence, or a thorough diligence process internally, included but not limited to:
  • Financial model
  • Technical specs/critical design reviews
  • Technical road map
  • Organization chart and hiring plan
  • Extended deck and market analysis
  • Market validation and customer references

Oftentimes, you’ll find that a VC will say you’re too early, and this means one of two things. The first being you are, actually, too early for them. Many VCs do have specific stage focuses, but usually you can tell before the pitch if you’re outside of that range. Oftentimes VCs use the “too early” excuse as a vague way to pass on your startup without giving real feedback because your pitch was bad. 

Push back on the VC. If they continue to be vague, it means the problem is you and the pitch. If that’s the case, you have two options: pitch coaching or hiring a sales/business-background CEO who can pitch the company instead. Your CEO is quite literally the Billy Mays of your business. Oftentimes, at the early stages, you’re selling the dream of the OxiClean instead of the actual performance. 

Venture capital only solves some of your problems

The solace I can give you is that fundraising is supposed to be hard. Unless you’re in a hyped sector or an experienced operator, I usually prescribe 400+ conversations before you end up completely closing and filling a round. You have to find VC fit — they often say these relationships last longer than your average marriage. However, when you accomplish a fundraising process, you set your business up for two or three years of runway to chase your dreams.

 But if fundraising is too hard, it’s important to think about the reasons why. In the next few posts, we’ll go through some of the key methods we use to fix storytelling for hardware and some of the other key questions and issues that come up. But it’s also always possible that your business might not be a fit for venture capital, or in frequent cases, it’s not a fit for venture capital right now. It doesn’t mean that it’s a bad idea to pursue it, it just means you need to find another way to finance the company. And that’s OK too. MailChimp was completely bootstrapped, sold for $12B. In the hardware space, GoPro and countless other successful products and companies all found their way without venture capital financing.

informal is a freelance collective for the most talented independent professionals in hardware and hardtech. Whether you’re looking for a single contractor, a full-time employee, or an entire team of professionals to work on everything from product development to go-to-market, informal has the perfect collection of people for the job.