How VCs Use Kickstarter to Kick the Tires on Hardware Startups

Photographer: Matthew Lloyd/Bloomberg

Gamers wear high-definition virtual reality (VR) headsets, manufactured by Oculus VR Inc., as they a play video game during the Eurogamer Expo 2013 in London. Oculus raised $2.4 million on Kickstarter in 2012 for the development of its virtual-reality gaming goggles, with donations ranging from $10 to more than $5,000. Close

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Photographer: Matthew Lloyd/Bloomberg

Gamers wear high-definition virtual reality (VR) headsets, manufactured by Oculus VR Inc., as they a play video game during the Eurogamer Expo 2013 in London. Oculus raised $2.4 million on Kickstarter in 2012 for the development of its virtual-reality gaming goggles, with donations ranging from $10 to more than $5,000.

It can be a hard life for hardware startups. Investors are nervous enough about backing an unproven product. Add to that the costs of manufacturing and you can understand why purely digital startups may seem like a less risky bet.

But some of that fear is being eased by crowdfunding platforms such as Kickstarter and Indiegogo, where startups can raise money from the public to build prototypes or start manufacturing their product. Successful campaigns on those sites can answer a lot of the initial questions that venture capitalists have. And lead to investments.

During the first half of this year, 26 percent of the 73 hardware startups that received venture funding had also raised money through a crowdfunding site, according to a report released today by research firm CB Insights. That's up from 18 percent in 2013 and 10 percent the year before.

In the minds of VCs, crowdfunding sites have helped shift the question from whether the idea "will have a product-market fit" to "can the company execute and scale manufacturing," said Sean O'Sullivan, managing director at SOSventures, which developed a number of accelerator programs including one focused on hardware startups called HAXLR8R.

A crowdfunding campaign allows a VC to "talk to customers, track return and/or failure rates, and then fund expansion with real data," said Barry Schuler, managing director at DFJ Growth, in an e-mail. He's also on the board of Formlabs, a maker of lower-cost 3D printers that raised $2.95 million in 2012 on Kickstarter with more than 2,000 backers. DFJ Growth and SOSventures both participated in a Series A funding round about a year after the Kickstarter campaign.

"It becomes an ultimate test market," he said, referring to crowdfunded campaigns that successfully deliver their products. Schuler, who was one of Formlabs' first customers, sees crowdfunding as a good way to scout out promising new products.

Campaigns also involve attractive descriptions of the product as well as good demo videos, which can give investors "some perspective on their marketing skills and sales skills," said Anand Sanwal, CEO of CB Insights.

While hardware startups are making some splashes, they still make up a small portion of total venture capital funding and the number of investments made. Venture capitalists invested in 3,354 startups in 2013, and 3.8 percent of those were involved in hardware, according to CB Insights data. In the first half of 2014, 3.9 percent of 1,854 that received funding from investors were hardware startups.

O'Sullivan expects the trend to accelerate as demand for devices connected to the Internet, such as wearables, heats up.

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