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Hardware Startups Focus on Software to Lure Investors

Hardware Startups Push Software Technology
TechShop, a membership-based do-it-yourself workshop in Menlo Park, CA, where prototypes can be made. Photographer: Gabriela Hasbun/Redux

Leap Motion was able to entice venture capitalists to invest $14.6 million in its motion-sensor device for controlling computers using just a wave of some fingers. The company was luckier than most.

Entrepreneurs aspiring to build technology products that customers can physically hold are finding it increasingly difficult to raise money, reported on its Tech Deals blog.

Software startups netted 34 percent of the $11.9 billion venture capitalists invested in San Francisco Bay-area technology companies last year, while consumer-electronics makers received just 0.26 percent, according to the National Venture Capital Association and data compiled by Bloomberg. The $30.5 million that venture capitalists put toward consumer-hardware companies was about half the amount they invested in 2010, the association said.

“These are tough businesses to bet on,” said Andy Miller, a San Francisco-based partner at Highland Capital Partners LLC, an investor in Leap Motion. “Totally more risk, bigger reward.”

Michael Buckwald, Leap Motion’s co-founder, said he downplayed the hardware aspect of the gadget, which consists of two cameras and several infrared beams, and instead touted its underlying software code to investors. It’s a strategy that worked for Apple Inc.’s Steve Jobs, who referred to the maker of iPods and iPhones as a software company.

Apple’s $108.2 billion in sales last year notwithstanding, hardware companies remain less attractive to investors primarily because of the expense to make and distribute physical products. There’s also less cost involved if software developers need to scrap designs and start over if a concept doesn’t pan out.

Better Days Ahead

“Historically, consumer electronics hasn’t been a forte area of investment for venture capitalists,” said Charles Chi, who previously managed investments for Greylock Partners.

Greylock was the first to invest in Lytro Inc., which makes a camera shaped like a stick of butter that lets users change the focus of photographs after they’re taken. Putting some $2 million into a prototype, which started as little more than a clunky box tethered to a computer when Greylock first invested in 2008, was a “high-risk bet,” said Chi, who is now the executive chairman at the Mountain View, California-based Lytro.

Conditions are improving for hardware startups, venture capital aside. Low-cost manufacturing facilities in Asia are more accessible to startups in particular, thanks to U.S. prototyping facilities such as TechShop.

In addition, direct-to-consumer online retailing and social-media marketing are almost free.

Underestimating Hardware

When Eric Migicovsky was unable to get venture capital for his product Pebble, which came out of the Y Combinator business incubator, he turned to to tout his prototype and raised $10.3 million in less than a month. Pebble is a wristwatch that communicates wirelessly with an iPhone or an Android device, said Migicovsky, who co-founded the company.

Venture capitalists “underestimate the time, the money, the management, the manufacturing,” said Tony Fadell, a Nest Labs Inc. co-founder and former Apple executive who helped design the iPod. “They don’t treat hardware as a really difficult thing to build and produce and service and maintain. They under-think it at the beginning because they think, ‘Oh, we’ll just throw it over the wall to China, and they’ll make it.’”

Leap Motion is exploring licensing the technology behind its $70 computer peripheral, which is being assembled in China, Buckwald said. The company received financing from firms including Highland Capital, Founders Fund and Andreessen Horowitz. Bloomberg LP, the parent of Bloomberg News, is an investor in Andreessen Horowitz.

‘Strong Desire’

Once the fundraising was finished, Buckwald said it has become easy to hire prospective employees with expertise in hardware. His 20-person company is receiving at least 100 job applications per week because many engineers are attracted to the idea of contributing to a shiny product they can hold in their hands, he said.

“There’s a strong desire to build real things, particularly with hiring engineers,” Buckwald said. “Hardware puts us in control of our own destiny.”

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