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Why VCs Use Crowdfunding To Make Sure Their Hardware Startups Pay Out

This hardware startup already had the money. What more did it need from crowd investors?

Why VCs Use Crowdfunding To Make Sure Their Hardware Startups Pay Out
[Packs of dollars: Skylines via Shutterstock]

Last year, the hardware startup Canary set up an Indiegogo campaign for its wireless home security system. Expecting to raise $100,000, it ended up raising nearly $2 million, approaching 2,000% percent of its funding goal.

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What you may not have realized unless you read the fine print is that Canary already had a solid sum of money on hand before the campaign ever started. The company had raised $1.2 million in seed money from Two Sigma and Brooklyn Bridge Ventures. This Indiegogo funding round seemed like icing on the cake. Or was it?

It turns out that hardware investors have a soft spot for startups that opt for crowdfunding. In Canary’s case, its seed investors were ecstatic that its Indiegogo campaign went so well, making their investment in the company that much sweeter. To whit: Khosla Ventures led a $10 million Series A investment round after the Indiegogo campaign.

It turns out that running a successful crowd funding campaign costs money. In fact, Canary raised the seed money to ensure the its Indiegogo campaign went smoothly. The funding helped bring on developers and solidify its product’s design in time for the campaign’s presentation.

“Once we did [rapid prototyping] it was easier to then take all that work and plug it into a site like Indiegogo, where we could tell a great story, figure out our product-market fit, make sure that there was a big enough market for them, and then fund the first round of actual product,” says Andrew Kippen, head of marketing at Canary.

Canary’s wireless home security device.

The crowdfunding campaign gave Canary a straight path from presenting the initial product to selling it in the marketplace. This may or may not have been possible with seed money alone–depending on the amount, it might not even fund a company long enough to manufacture the first set of prototypes.

It just doesn’t happen all the time, says Colin Beirne, partner at Two Sigma Ventures, one of the investors in Canary’s seed round. Usually, guaranteeing funding for manufacturing requires more capital, which is invested later in a startup’s life. So that’s where crowdfunding comes in handy.

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“The way we see it is that crowdfunding funds the product, and then VC funding funds the company,” Kippen says.

The seed round typically does the job of growing the company and giving it the resources to get the right market feedback and solidify the product’s design. Manufacturing is just a glimmer in the eye of the investors at that point. “As an investor you have a sense of the amount of seed capital required to build the team and move toward manufacturing, which is independent of any money that might be raised during a crowdfunding campaign,” says Beirne.

Crowdfunding campaigns give an advantage to a startup because they speed up this market feedback process. And crowdfunding sites make it simple to put the product’s technical specs up for users to peruse and have a video at the ready.

The other huge benefit of the crowdfunding round is it takes the guesswork out of how much product to manufacture and at what cost. Without crowdfunding, a VC-backed company might drag its feet on deciding price points and initial product volumes when conducting research through traditional means.

In essence, Canary’s Indiegogo campaign was a plug-and-play storefront. With its seed funders’ resources in hand, the Canary team could attract its first real customers, while unlocking even more funds from lay citizens.

“It’s not really crowdfunding. It’s a presale, actually,” says Charlie O’Donnell, partner at Brooklyn Bridge Ventures, Canary’s other seed funder.

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According to O’Donnell, crowdfunding is tantamount to a marketing channel with very friendly financial terms. It gives the startup a way to gauge how much to charge for its hardware product. And the capital is just a side benefit of the massive market feedback the company gathers from its backers. It takes the pressure off of both the seed investors and the company to figure out how to fund the manufacturing stage.

“We don’t have to put out $1 million to make $2 million worth of product because our customers are willing to front that for us,” says O’Donnell.

Indiegogo has helped several VC-backed hardware companies, like Canary, run successful crowdfunding campaigns.The wearables startup Misfit came into its Indiegogo campaign with seed funding. Afterwards, it attracted $15 million for its next round of funding. The company Muse also started its campaign after receiving seed money for its brain-sensing headband. Both Misfit and Muse have led some of Indiegogo’s more successful hardware campaigns.

In just this past year, Indiegogo’s tech category has grown by 1,000%. It’s a category that mainly consists of hardware products, ranging from connected devices and wearables to robotics and drones.

“For them, oftentimes what they use Indiegogo for is to demonstrate market traction to get user feedback, to create evangelists. It helps investors. It helps to de-risk those investments,” says Kate Drane, the design, technology, and hardware lead of Indiegogo.

Drane increasingly sees more seed investors urging their fledgling hardware startups to seek crowdfunding after they dole out the first check. After the crowdfunding round, these companies have little problem attracting their next round of funding.

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In Drane’s view, there are three types of campaigners. First, there’s the hobbyist, who develops a product in his or her free time and wants to mainly finish it out for personal reasons. Second, there’s the person who is already developing a product at a company and wants to refine it. Finally, there’s a company that wants to launch a product and uses a site like Indiegogo to get to market.

It’s this third type of campaigner that has really made products more visible in the hardware space. Crowdfunding is a way for these startups to gain market traction, demonstrate user interest, and get user feedback. It also reduces the risk companies take in moving into manufacturing.

“We really started seeing growth in this category in October 2012,” says Drane.

At the time, Muse was running its campaign. Since then, companies like Misfit, Jibo, and Solar Roadways have led successful campaigns, hitting the $2 million mark. Skully, a smart motorcycle helmet, is currently live on Indiegogo and is close to joining this two-million-dollar club.

An investor told Drane that he appreciates it when startups do Indiegogo campaigns because the company could report detailed consumer feedback to him. One company could tell him what the open rates were whenever it sent out an email. The high engagement rates and analytics he saw from the campaign impressed him.

“It’s not only the money, it’s not only the amount of funders, it’s not only the coverage that you get. That is part of it. It’s those data points as well,” says Drane.

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The data can help a company put down a solid strategy to move forward with manufacturing. One way to do it is by surveying backers after a campaign. The 1:Face Watch startup did just this. It leveraged its engagement channel to figure out how to scale its manufacturing plan for mass production.

“By the way that people were contributing to those campaigns, they were able to make relatively smart decisions about the different scales,” says Drane. For 1:Face Watch, if they sold five blue, 15 red, and 85 black watches, they were eventually able to turn those initial sales into percentages to estimate mass production categories.

Now that Canary is preparing for mass production this fall, its Indiegogo campaign is proving its worth. The concrete sales numbers have made life easy.

“For a hardware company, you don’t have the luxury of putting out an initial version of the product and then iterating quickly, and continuing every month, shipping out a different version when the market gives you feedback on what they did like or don’t like,” says Beirne. “The hardware innovation cycles are longer.”

Since its crowdfunding round, the Canary team has been finishing up its internal and external testing on its product’s final design. Indiegogo’s campaigning structure let Canary condense its market research and initial sales efforts into the course of one month. So the team spent its time on the thing that matters the most–turning out a high-quality product.

But neither Beirne’s nor O’Donnell’s seed investments in Canary depended on the outcome of its crowdfunding campaign. They simply saw the company as a good investment.

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Beirne recognizes crowdfunding’s perks that market research and production estimates get fast-tracked. Nonetheless, when deciding to invest in Canary, he was confident that the company would have been able to demonstrate its market value well, with or without crowdfunding. O’Donnell agrees.

“For me, actually, the thing that Indiegogo proved was that, for a former Israeli army security defense guy, and a hardware geek, they were actually pretty good at marketing!” O’Donnell says.

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About the author

I write about science and technology in the global marketplace, with a bent towards women in STEM. My work has appeared elsewhere in Quartz, Fortune, and Science, among others. I'm based in Amsterdam. Follow me on Twitter @tinamirtha.

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