Dawn of a new era: lean hardware startups

I don't feel comfortable coining new terms as I think that's the job of the journalists (and whichever superstar opion leaders they follow closely). However, during my trip to Asia this time I found myself forced to create two terms and use them more and more often to facilitate the communication:

  • Lean hardware startups
  • Californian Applish English

Please be reminded that these two are highly stylized terms and shall not be taken at face value. They are "relatively" accurate and proper when put into the right context, which in many cases is the context of what we're doing in Hardware Club.

I will talk about the 2nd term in maybe another article though I believe the name has already given people hints about what I am referring to. In this article I'll cover the first and arguably very arguable term: lean hardware startups.

Obviously I'm stealing a page from the glorified realm of lean startups. Since the birth of Netscape this type of startups – starting lean and once hitting the viral loop, boom! – has gradually become the center of the venture investment universe.

Back in the 80's and early 90's venture investments in Silicon Valley and around the world were all about technologies, hardcore heavy-weight hi-tech we might say. At the dawn of the lean startup era (Hotmail, Google, eBay, Paypal), you built compelling consumer applications that were powered by superior technologies. Entry barrier came both at technologies and network effects. Then came the age of viral startups that could be easily copied but relied on fast and onerous execution to reach the critical mass and therefore dominance, such as Youtube. Then the really glorious age was ushered in with the likes of Facebook and Twitter, who almost never talked about technology or patents but were able to rely on sheer network effects to grow to dominance. Now we might be seeing the two superstar lean startups, Uber and Airbnb, go IPO in the coming months.

The lean startups have become so dominant that there emerged even a spray-and-pray investment model that largely ignores entrepreneurs but focus on geographical macros and firm KPIs – the now very famous 500 Startups.

However, for better or worse we could actually say the lean startup era has reached a pinnacle since many of the early stage lean startups today are receiving huge sums of cash – there's a definitive money-chasing-deals behavior now in venture investments, especially in the United States – to run their lean startups. As a result many of them are not actually lean anymore and the money infused into early stage startups these past two years probably won't hit the VC required rate of return even taken as a group.

On the other hand, despite the structural change and the exciting exits of Nest (Google), Oculus (Facebook) and SmartThings (Samsung), hardware startups are still seen by most investors as capital inefficient and still receive much less capital and probably at inferior valuations.

iSKN's beautiful iSketchnote

iSKN's beautiful iSketchnote

iSKN, a french startup who developed a system to transcribe directly whatever you sketch with your real pen on real papers into beautiful vector files on your iPad, recently celebrated the closing of their first big round of a whopping — $2M. 

Honestly speaking we're all very happy for iSKN, a fellow Hardware Club member – you could actually see my partner Alexis Houssou appearing in their campaign video (see the end of the post) – and the investors they got this time are really top-notch in Paris: Partech, Kima Ventures and former Apple GM of EMEIA Pascal Cagni. Still if you take the $2M to any TechCrunch event and you'll be drown by a bunch of lean startups who have received multi-million seed funds with barely working app prototypes. At the extreme end of this crazy lean startup age, the story of Clinkle, which has received $30M in investments without ever showing a working app, is now well documented.

But even at a more rational part of the spectrum, lean startups are not always as lean as some naïve tech news followers would believe. This TechCrunch article about the cash burn of the SaaS model is a very good demonstration.

For SaaS startups, they're investing heavily upfront, both in development and in cloud, in return for hopefully a long-term revenue stream. The faster they grow, the more capital they have to raise to burn upfront simply due to a mismatch of receivables and payables. In other words, most of the investors' money is used to sponsor the very unsexy term of Working Capital. Of course, if the product offering is really good, such as Salesforce.com good, this kind of investments will see tremendous returns (at least in valuations) in 3 or 4 years. On the other hand, if these startups fail to keep users glued to their services, i.e. the churn rates are too high, then they would run out of cash faster than any hardware startups you could imagine.

I guess my point is: lean startups today are not as lean as a causal reader believes. 

Given this grand narrative, we could actually make a strong case for the term "lean hardware startups" for the following reasons:

  • The advance of SoC (system-on-a-chip) and turn-key system solutions has dramatically lowered the cost of hardware innovations on the application end. Today entrepreneurs with proper expertise could source semiconductor chips, wireless modules and ARM subsystems directly from many on-line sources and start building their own smart systems.
  • The emergence of 3D printing further helps the hardware startups to prototype the housings relatively easily. Handiii, the fascinating Japanese startup that I met in Tokyo even build their final products, beautiful and smart prosthesis hands, using 3D printing!
  • Finally the most important structural development for hardware startups – the emergence of Kickstarter as the first huge funding source. In the old days, the HW startups have to raise money from investors to produce their prototypes and first batch of products. Since this usage of capital is relatively inefficient, the money they raise will take up equities of 30~40%, if not more. Later when the startups go on to raise the next round, the new investors will simply take a look at the Cap Tables and walk away. It's simply not gonna meet their required rate of return. However, today the greatest hardware startups raise their first big round of money for production from their end customers! There is zero equity dilution. Even more beautiful – this is the reverse of the receivables-payables mismatch! While lean SaaS startups have negative working capital, these HW startups have positive working capital for their first phase of mass production!! Consumers are paying in full way in advance – anywhere from 6 months to 18 months – to buy the products that excite them. The startups can then use the money to learn operations and logistics through their first mass production. At the same time, Series A investors look at the clean Cap Tables and now it has become an investable business. In short, the emerging of Kickstarter has delayed the equity dilution by an entire round and peeled away considerable investment risks, making investments in hardware startups interesting again.

Now to be honest hardware startups will never scale as fast as successful lean startups. However, we here at the Hardware Club believe that we're at the dawn of a new era where lean hardware startups will follow a totally different pattern to successes (or failures). And we're going all out to help the hardware entrepreneurs to not just be part of the wave, but also the wave makers!

Therefore if you are a hardware startup, don't hesitate to drop me a message at jerry@hardwareclub.co. I'm all ears!

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* See below for iSKN's campaign video. My partner Alexis Houssou is (almost) the leading actor. In Hardware Club we go really beyond imagination to help the startups.

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