Product Startup Podcast Episode 178: Venture Capital for Hardware Startups

00:00:00 Kevin Mako: Hello, product innovators. Today we learn from the CEO of a $200 million VC firm on best practices for raising venture capital funding for your hardware startup.

00:00:08 Narrator: You're listening to the Product Startup podcast, a show to learn from top leaders in product development, prototyping, manufacturing, product selling, and everything in between.

00:00:16 Narrator: Hosted by Kevin Mako, the leading expert on product development for physical product startups,

00:00:20 Narrator: sponsored by PTC's two best-in-class 3D CAD product development software solutions Onshape and Creo,

00:00:26 Narrator: and produced by Mako Design + Invent, the original firm providing world-class,

00:00:30 Narrator: consumer product development services tailored specifically to startups small manufacturers and inventors

00:00:35 Kevin Mako: welcome back everyone today i'm very excited to introduce Toph Day to the show Toph is the CEO of elevate ventures a venture capital firm that has many hardware companies in

00:00:44 Kevin Mako: its portfolio of over 220 million dollars of investments under management he has founded eight

00:00:49 Kevin Mako: companies with over 600 million dollars in transactions over the past 30 years today

00:00:54 Kevin Mako: Toph is going to share some valuable knowledge for inventors startups and small manufacturers on what venture capital funding is, if VC funding is right for you, and some advice on

00:01:02 Kevin Mako: how to plan for and pitch your hardware startup to VC firms. Now, on to the episode.

00:01:09 Kevin Mako: Hey, Toph, welcome to the show. Thanks, Kevin. Excited to be here. Well, we're really excited today to talk to you about venture capital funding, especially for hardware startups.

00:01:16 Kevin Mako: It's something that so many hardware startups consider or are thinking about or going through the process of what better person to bring on the show today than

00:01:23 Kevin Mako: you to talk about this. You've been doing this for 30 years, hundreds of millions of dollars in

00:01:26 Kevin Mako: transactions that you've worked with well over 100 companies in the space doing all kinds of different

00:01:31 Kevin Mako: things in terms of advisory, actually raising funding, or actually investing in these companies.

00:01:35 Kevin Mako: So you know about VC funding and how companies should be both pitching and understanding where that fits into the matrix of their overall business scaling plan.

00:01:44 Kevin Mako: So before we get into all that,

00:01:45 Toph Day: how did you get to where you are today? That's a great question, Kevin. Sometimes I don't even realize how I got to where I am today.

00:01:51 Toph Day: I would say standing on the shoulders of giants and being surrounded by people who are smarter than I am to go try and solve problems. It's been amazing. I think early on,

00:01:58 Toph Day: when I was a teenager, I knew I wanted to own my own company someday. I had a painting company in college. That's how I paid my way through school.

00:02:04 Toph Day: But then I went on to start a broadband company. I got bit by the technology bug, so to speak, and that was back in like 1997 timeframe. And then

00:02:11 Toph Day: that kind of sent me off on a path that was unintentional, but ended up starting eight different companies in seven different verticals.

00:02:17 Toph Day: And that was anywhere between software and hard tech and family entertainment and real estate and dot-com business, bottled water, you name it, it feels like

00:02:25 Toph Day: I've been involved in it. And it's just been an incredible journey. And that all led to taking over as the CEO of Elevate Ventures last July.

00:02:32 Toph Day: And Elevate, we've invested in over 520 companies cross-sector. There's been 130 exits. Also done my own angel investing, et cetera, over the years. So that's kind of

00:02:41 Kevin Mako: a quick, high-level summary. Yeah, that's amazing. What a story. And that teases up very nicely.

00:02:46 Kevin Mako: Explain to those who are getting into venture capital, we're just learning about it for the first time.

00:02:50 Kevin Mako: Just describe a bit about what venture capital is and how that kind of fits within other types

00:02:54 Toph Day: of funding rounds. Yes, absolutely. So venture capital is a more sophisticated process of

00:02:59 Toph Day: investing, you know, as opposed to friends and family or angel investors. And that doesn't mean

00:03:04 Toph Day: that, by the way, friends and family, but friends and family and angel investors, those are all

00:03:08 Toph Day: sophisticated folks, obviously, have been successful or they wouldn't be able to invest. But venture

00:03:12 Toph Day: capital kind of layers in an additional element of rigor to the vetting, the diligence, investment, and post-investment stewardship process. As founders are,

00:03:20 Toph Day: thinking about embarking on venture capital. The short story is you want your story, your message,

00:03:26 Toph Day: your go-to-market plan, your financial projections to be very tight. And you don't want to come in the

00:03:32 Toph Day: door and start saying you've got a unicorn on your hands if there's no evidence of having a unicorn on your hands, right?

00:03:37 Toph Day: That's just a surefire way of kind of wasting an hour of time. I would say at a high level, we get to more specifics here. But I think at a high level, it's an elevated

00:03:44 Kevin Mako: level of rigor and discipline in the process of growth. Let's talk a bit about hardware and what that means. Typically, from the product development side, we see obviously a lot of

00:03:53 Kevin Mako: people, they start in the early, early stages of the ideation and the industrial design and mechanical engineering, electronic engineering, rough prototyping, all that.

00:04:02 Kevin Mako: That's generally self-funded or, say, friends and family. And as they get a bit more developed into like physical products, they move potentially into more

00:04:10 Kevin Mako: sophisticated angel investors or actual professional angel investment networks and whatnot once they've actually kind of got a physical validated product.

00:04:17 Kevin Mako: But that's usually still a bit premature. for venture. And I think when you're talking here about showing a really clean, clear pitch,

00:04:25 Kevin Mako: generally it seems to be from the development standpoint, at least from a we see with the hardware

00:04:29 Kevin Mako: startups that are emerging in the hardware tech space, you've got to have at least some provable sales production, that sort of thing, to indicate that you're now ready to scale.

00:04:38 Toph Day: Let me know what you've seen from your perspective. So all venture capital firms are not created equal. That's number one I would mention.

00:04:43 Toph Day: So really make sure that if you're going to reach out to venture capital firms, understand what phases they invest in. And so one thing is really important.

00:04:49 Toph Day: is number one, does that venture capital firm even invest in hard tech? And number two,

00:04:55 Toph Day: what stages do they invest in? If they're a series A investor, you want to be really self-critical of how you spend your time.

00:05:01 Toph Day: And if you're four years away from series A, you probably don't want to spend your time having those discussions. You do want a relationship built at some point,

00:05:09 Toph Day: but you don't want to have those conversations too early because you're going to have a lot of cycles

00:05:12 Toph Day: and think that they might invest, but they have no intention of investing yet because you don't meet their mandate, their thesis.

00:05:18 Toph Day: Another thing that we see is how companies are structured. So as we all know, folks that are listening, if you're in hard tech, it's hard.

00:05:26 Toph Day: It's expensive and it's hard. Just creating a form factor, right? There can be many mistakes and errors that are made and trying to build just a basic

00:05:32 Toph Day: form factor for whatever you're building. But one thing that we see is, I want to come back to structure for a moment.

00:05:37 Toph Day: When you first start your company, it's really important to keep a clean legal structure. And so a specific example I'm going to give is the misuse of safes.

00:05:46 Toph Day: So simple agreement for equity. So these came about, they were invented by Wycombinator to help them do high velocity standardized investing.

00:05:54 Toph Day: And they were first meant for an event, a moment in time. Things were not taking to account in how those safes are treated as a securities document, for example.

00:06:04 Toph Day: And so what's happened over time is people are using these safes and different versions

00:06:08 Toph Day: of these safes, modifying them and stacking safes on top of safes with different conversions, different caps, side letters associated with them, et cetera.

00:06:15 Toph Day: And what they don't realize that they're doing is they're creating a lot of complexity down the road where, number one, VCs will not even touch the deal because it's so messy.

00:06:24 Toph Day: When you go to try to convert all those safes, if there's a concept now of a post safe, which means basically all the dilution occurs pre-money, that's not founder-friendly.

00:06:32 Toph Day: You're shooting yourself in the foot and creating more dilution for yourself unintentionally because nobody ever maps these safes out to understand what happens to the cap table.

00:06:39 Toph Day: Several pieces of complexity there. Well, one thing I would just really encourage all entrepreneurs, and especially those are not.

00:06:45 Toph Day: hard tech, safes were never meant for phased investing, for a phase of investing, a phase being over multiple years. They were meant for an event.

00:06:53 Toph Day: And so just use a convertible note. It really doesn't cost that much different. It's going to save you a few thousand dollars now can literally save you

00:07:00 Kevin Mako: millions of dollars in the future. Wow, that's powerful. One of the things that we always see,

00:07:04 Kevin Mako: of course, and it's akin to any business, but especially in hardware, the further that you can push it yourself without getting investors on, the cleaner that it is, right?

00:07:12 Kevin Mako: Or if you're doing friends and family and some relatively simple investment instrument. If you're structuring it properly and

00:07:18 Kevin Mako: cleanly, that's something where as you push it down that row, you've got less and less of these

00:07:23 Kevin Mako: layers. As you mentioned, as you start stacking these safes and convertible notes and other

00:07:26 Kevin Mako: investment vehicles, one on top of another because I'm extremely complicated. I find it very

00:07:31 Kevin Mako: interesting. In fact, you mentioned that if it becomes too complicated, just the legal structure alone, VCs won't even touch it.

00:07:37 Kevin Mako: So you've already shot yourself on the foot before you get out of the gate. Doesn't matter how great your product is, right? So be very careful with these

00:07:43 Kevin Mako: instruments and know what time is right to look at the certain type of investment that you're looking

00:07:48 Toph Day: at for that exact moment in your particular business. Yeah, 100% agree. Just to beat that horse one more time, I would just say, just stay away from safes all together.

00:07:57 Toph Day: Unless in the YCOM scenario, I can objectively understand why they use it and it could make sense in their situation.

00:08:03 Toph Day: High volume, high velocity, one-time investment in that company's either going to be dead or alive

00:08:08 Toph Day: in 6-12 or 18 months, which the intent was it for it to convert into equity at that next round in

00:08:12 Kevin Mako: six, 12, or 18 months, I can understand maybe in that scenario it plays. That's really good advice. And it's important to consider when you're looking at these funding

00:08:20 Kevin Mako: rounds as well, looking at the quality of what you're offering obviously improves over time. And when you look at hardware, hardware has a few steps to scale.

00:08:27 Kevin Mako: We already talked about the things from design to prototyping and engineering on to short room manufacturing and full scale manufacturing and so on as it grows.

00:08:34 Kevin Mako: So you will likely go through funding rounds one way or another, whether you're using something like crowdfunding to maybe bridge a gap between one level

00:08:41 Kevin Mako: on another level of your hardware business. Either way, you're likely going to go through either

00:08:45 Kevin Mako: funding rounds or if you're growing fast enough through pre-sales revenue, that in and itself

00:08:49 Kevin Mako: is a way of looking at a funding round in essence from your customers that you will have to deliver

00:08:53 Kevin Mako: on. So all of these things really factor into an important formula of keeping it simple, keeping it clean and providing as much values you can to those potential stakeholders,

00:09:03 Kevin Mako: whether it be investors and customers or various types of investors, grants, etc. One of the best

00:09:07 Kevin Mako: things, of course, you can do in hardware is continue to progress the technology. If you are too early for a particular type of funding.

00:09:13 Kevin Mako: Look at options where you're at and then look at what you need to get to in order to get to that, let's call it minimum level that's required to

00:09:21 Kevin Mako: maybe approach that particular VC that needs to see some level of sales or whatever else. But the further you push it, the more attractive your proposition becomes to all of these

00:09:30 Toph Day: different types of investment vehicles. 100% agree. One thing else I would add at this stage is

00:09:35 Toph Day: market validation, maybe even ask for non-binding letters of intent. And that's also how you can

00:09:40 Toph Day: test pricing, elasticity, like what are people willing to really pay for this thing? But don't be

00:09:45 Toph Day: afraid and just be transparent about it, right, on where you are in that journey of bringing that hard tech device to market.

00:09:51 Kevin Mako: Don't be afraid to approach those innovation groups, biz dev groups, et cetera. Like that. Now, you're a big advocate of partnerships and other things in terms

00:10:00 Kevin Mako: of scaling and building the business. Talk a bit about that and how that plays into the whole

00:10:05 Toph Day: venture capital world and really the attractiveness of a business. Yeah, 100%. If I think back to the first company I started in 89, was the very first company I started.

00:10:13 Toph Day: And I fast forward to today, how you build a business, how you go to market is just night and day. There are many businesses out there.

00:10:21 Toph Day: You can still go out and build, call it a lifestyle business. You remain in full control and you kind of take a stair step at a time and grow an incredible, wonderful business.

00:10:28 Toph Day: In a lot of sectors, so hard tech or software, et cetera, people are leveraging partnerships in capital to get to that next milestone faster.

00:10:36 Toph Day: And then the world just changed again 90 days ago, right, with all these AI tools now coming out at our disposal.

00:10:42 Toph Day: And now we see companies also spinning up that are, right, just like I think your company. And there's others that have the sole purpose.

00:10:49 Toph Day: Actually, you started just, I think, a long time ago, like 20 years ago, right? But they have the sole purpose to more efficiently bring that hard tech device through the phases

00:10:56 Toph Day: that you just mentioned to help bring that thing to market. I would say very seldom from what we see today of all the companies, we get roughly six

00:11:03 Toph Day: pitches a week is the velocity, right? It's high velocity. So we see lots of different types of companies and different.

00:11:08 Toph Day: different sectors, very, very few of them, or maybe I should flip it the other way and say the ones

00:11:13 Toph Day: that are typically the most successful to make it through from vetting to pitch to diligence to actual investment, they are surrounded by partners.

00:11:21 Toph Day: And so it's very easy to make hiring mistakes in your early days. And so working with a partner who's figured out a really efficient model to build

00:11:30 Toph Day: the prototypes, to build form factors or whatever, because those are no doubt going to require multiple, multiple iterations.

00:11:35 Toph Day: It's just a requirement that you've picked those partners early,

00:11:38 Kevin Mako: to be as efficient as possible, right, as you try to bring that product to market. That's very powerful advice, especially getting in earlier, the better.

00:11:46 Kevin Mako: I mean, that's one of the big things on the product development side. If you can really build a product foundationally strong with best practices,

00:11:52 Kevin Mako: not only in like modern, clean, beautiful design, but also using some of the best technology that exists. Yes.

00:11:57 Kevin Mako: But also pairing that with the ability for it to be very workable and hit certain standards that are required, possibly certification standards.

00:12:03 Kevin Mako: And then, most importantly, manufacturable because you actually have to produce the thing at the end of the day.

00:12:08 Kevin Mako: So those are layered stepping stones, but all come from a very strong foundational base to how you're actually building out, designing, iterating that model

00:12:17 Kevin Mako: right from day one. All of that is going to apply forward. And the better engineered your foundation is from the gecko, the significantly more

00:12:25 Kevin Mako: seamless, all of the different subsequent steps all the way through to and including production and then scaling production are all going to be generally even exponentially easier,

00:12:34 Kevin Mako: smoother, and simply lead to a better quality product that's better vetted, with, as you mentioned, user feedback, customer feedback, potential stakeholder feedback,

00:12:42 Kevin Mako: investor feedback, all these different elements, which should really lead to an iterative-based

00:12:47 Kevin Mako: approach, even in hardware nowadays, because we can rapidly iterate prototypes so quickly now

00:12:52 Kevin Mako: and with such closeness to manufactured quality goods that you have the ability to test

00:12:57 Toph Day: tweak and refine much earlier in the process, certainly than 20 years ago when I started the business. Also, the narrow and deep concept plays into hard tech as well.

00:13:06 Toph Day: It's really easy for entrepreneurs to kind of the old adage of squirrel and to want to kind of be all things to everybody and

00:13:12 Toph Day: well somebody else over here that's kind of a non-core customer but they're willing to write a $38,000 check.

00:13:18 Toph Day: If you can modify that technology to do this thing over here where there's a market cap of $10 million.

00:13:24 Toph Day: Well, okay, that might sound really awesome to get that $38,000 contract early on in your growth.

00:13:30 Toph Day: However, it takes you away from your core focus of a $500 million market that people will buy that widget for $25,000. And so really to stay true to that core mission,

00:13:40 Kevin Mako: narrow and deep of whatever the use case is with the highest and best use customers because it's just super easy to get distracted. I love that you mentioned that.

00:13:48 Kevin Mako: We talk about that a lot, but with that the design firm and on the podcast here, we call it feature creep, how deadly that is, especially to

00:13:54 Kevin Mako: hardware and especially as a hardware entrepreneur, it's tough because you want to create all these cool features that you think the market will need.

00:14:00 Kevin Mako: But the clear, undisputed reality is if you at some of the best product startups, essentially, especially in the hardware space, they generally

00:14:07 Kevin Mako: start with a very core offering, like the original innovation, like what was the aha idea that you had? Really hyper focus on that and focus on quality.

00:14:16 Kevin Mako: You cannot build quality if you're too diluted in terms of all these features you're trying to create. But if you really hyper focus on

00:14:22 Kevin Mako: just that maybe the one or two core features do an extremely good job in terms of reliability on

00:14:28 Kevin Mako: that, then you can let your customer base start to educate you on maybe what the next feature

00:14:32 Kevin Mako: will be or this enhancement might be so that you can wedge yourself into the market and then

00:14:36 Kevin Mako: expand and capture market share because you simply don't have the budget that a big corporation does to try and have the be everything to everyone product on day one.

00:14:44 Kevin Mako: Plus it takes them the years and millions and millions of dollars just to come out with that product. So don't try and compete head to head with that.

00:14:50 Kevin Mako: Compete head to head on your core innovation. Get that in there, do a good

00:14:53 Toph Day: job and then just expand like crazy after that from real customer feedback. It's just de-risking the whole process. Yeah, a wonderful example of that is I heard Damon John on

00:15:03 Toph Day: an interview recently and he said, hey, I can't remember who the founder of Under Armour is, but such and such and I, we started our companies at the same exact year, right?

00:15:10 Toph Day: Fibu and Under Armour. And he said, I wanted to go build all these incredible products and cool apparel, et cetera, for all these different people. And

00:15:18 Toph Day: Under Armour just wanted to go make the best Dry Fit T-shirt and look at both companies today.

00:15:22 Toph Day: Now, they're both awesome, but what Damon's saying is like, look at Under Armour, it's a lot bigger, right?

00:15:28 Kevin Mako: I'm not seeing bigger is better, but the point being narrow and deep typically get you farther. Yep, absolutely, especially as a hardware startup.

00:15:34 Kevin Mako: That's really key. I mean, I look at, especially in the teaching side, when I'm doing the lecturing at the master's engineering level, we do typical corporate design theory.

00:15:42 Kevin Mako: But it's very different than hardware startup theory. And the problem is a lot of hardware startups, look at that old traditional theory of how a

00:15:49 Kevin Mako: Fortune 500 company develops their next product. And it tries to apply that with startup funding. And they're missing a whole bunch of things, like being added.

00:15:57 Kevin Mako: Agile. And in fact, talking about agile design. Like agile design itself, the theory of that in hardware, right, how do you be iterative in your design process?

00:16:05 Kevin Mako: Focusing on MVP, focusing on wedging your core competency, not sacrificing quality, which is a key difference, especially from software, because there's no bug fix for hardware.

00:16:13 Kevin Mako: So especially the physical elements of hardware, right? That thing is released. People are not upset if it doesn't have all the bells and whistles they want, but they are

00:16:20 Kevin Mako: absolutely upset if you release them something and things simply are not working. And that really is a difficult situation to try and come back from.

00:16:27 Kevin Mako: So the fix to that early, we talk about the foundational logic is even when you're in that initial concepting phase, think about your core MVP, how you're

00:16:36 Kevin Mako: going to disrupt with that core original offering and do a great job of that and build the pyramid up

00:16:40 Kevin Mako: from there. I want to talk a bit about the conference that you have coming up because this is

00:16:44 Kevin Mako: amazing. You've got this conference basically that has a large hard tech component, a large startup component,

00:16:49 Kevin Mako: but you're also going cross industry and also both vertically and laterally trying to integrate a whole

00:16:54 Kevin Mako: bunch of different players to do something that's never been done before to really accelerate hardware startups and obviously many others.

00:17:01 Kevin Mako: But for the hardware startups listening to the show here, there's a massive component of that here.

00:17:05 Toph Day: And I think that everyone needs to know about it. So talk a bit more about what's happening coming up here in just a couple of months.

00:17:10 Toph Day: Yeah, absolutely. So we are launching a new conference. It's called Rally. And so the website is

00:17:15 Toph Day: Rallyinnovation.com. Rallyinnovation.com. The inaugural year is August 29 to 31st this year. It'll be in Indianapolis. And the plan is that this will become.

00:17:24 Toph Day: the world's largest cross-sector innovation conference. And we're very purposeful about those words. The reason is the world's changed forever.

00:17:32 Toph Day: Today's the slowest rate of change that you and I will ever experience, right, for everybody. And so especially with new technologies that have come on the

00:17:38 Toph Day: market in just the last few months, if you're in software or hard tech or healthcare or life sciences, med device, sports tech, ag, food, whatever, it doesn't matter.

00:17:46 Toph Day: There are all of these components that are cross-sector, across industry, cross-discipline, that are all required to bring

00:17:52 Toph Day: whatever that solution is to life, whether it's a soft good or a hard good. So we are very intentionally

00:17:58 Toph Day: building this conference from the ground up, and you can probably replace the word conference with festival or event.

00:18:02 Toph Day: But in year one, we're running a $5 million pitch competition, $5 million. And so there will be $5, $1 million winners.

00:18:09 Toph Day: So hard tech, software, sports tech, ag and food, healthcare. So $1 million winner in each of those categories. So pitch applications just closed last Monday.

00:18:17 Toph Day: Well, we have 450 pitch applications from 36 countries, all converging on Indianapolis to compete in this pitch competition.

00:18:26 Toph Day: That is really exciting. We're going to have keynotes, of course, that are cross-sector, featured speakers. We have over 200 total speakers. We have 50 content

00:18:34 Toph Day: sessions across those five sectors. We have another catch-all sector called entrepreneurship, and that's the catch-all for stuff we can't get to in year one.

00:18:40 Toph Day: We'll have investor one-on-one meetups with companies and vice versa. So we're super excited about this. I like to call it creative

00:18:46 Toph Day: collisions and bringing people together very intentionally cross -sector and disparate stakeholders. So cross-sector we kind of just talked about. But this idea of disparate

00:18:56 Toph Day: stakeholders is really critical as well. And so by disparate stakeholders, I mean not only startups and scale-ups and corporate, but also universities, also

00:19:04 Toph Day: economic development groups. All of these people are involved in the innovation ecosystem, whether it's actually starting

00:19:11 Toph Day: the company, whether it's providing dollars or whether it's providing grants or research and

00:19:15 Kevin Mako: development or talent. All of these things have to get more efficient working together. And that's the whole purpose of Rally. That's amazing. Looking forward to it.

00:19:24 Kevin Mako: And for everyone that's listening, I also put all the links to the show and to Toph's company Elevate. And we will keep you posted on that as it comes closer to the event as well.

00:19:34 Kevin Mako: Toph, thanks again for all your words of wisdom, helping out hardware startups. Think about venture capital and how that might play into their future for their hardware business.

00:19:42 Kevin Mako: Thank you, Kevin. Had a bless. Thanks. Thanks. Much appreciated. Take

00:19:45 Narrator: care. Thanks for tuning in to this episode of the product startup podcast. If you found some value in the show, please do us a huge favor and leave us a quick five-star review.

00:19:54 Narrator: If you have any questions, guest suggestions, or anything else, feel free to reach out to us anytime at our email, podcast at MakoDesign.com. That's podcast at MakoDesign.com.

00:20:03 Narrator: This show is hosted by Kevin Mako, North America's leading expert on product development for physical product startups.

00:20:09 Narrator: Huge thanks to our sponsors, PTC, and their two best-in-class 3-Cat product development software solutions Onshape and creo and Mako Design + Invent the original firm providing

00:20:18 Narrator: world class consumer product development services tailored specifically to startups small manufacturers and inventors thanks for joining and see you next time