Software Out, Hardware Start-Ups In


Software companies are so last decade. Instead, venture capitalists are looking to hardware companies for investment opportunities and the next big wave of innovation.

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Investors and entrepreneurs avoided hardware for years because the space was just too risky, but that's changing.

"There's a lot of stuff going on in the hardware space," said Scott Miller, former manufacturing head at iRobot and founder and CEO of Dragon Innovation, a consulting firm that works with start-ups and entrepreneurs to get their products made. "A huge wave is coming, and we aren't even at the beginning of it yet. The sea is just beginning to swell."

According to experts, hardware's rebound stems from several factors, including software advancements, new funding platforms (such as Kickstarter and Indiegogo) and wider access to prototyping technologies like 3-D printing.

But one of the most significant drivers is the mass adoption of smartphones, said Trae Vassallo, a partner at Kleiner Perkins Caufield & Byers.

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"The thing that is fundamentally different today, even more so than just two years ago, is the explosion of smartphones," Vassallo said. "The implications that has on hardware companies is massive. Before smartphones took off, it was incredibly expensive to build a smartphone-like platform product. ... It's been incredibly transformative."

Smartphone platforms enable entrepreneurs to cheaply build other products that leverage the phone's technology to collect data and perform other tasks. Examples include wireless wearable devices that track a person's activity or behavior, connected home devices that help conserve energy and robotics.

"Connected devices in the last 10 years revolved around software companies, but in the real world you interact with atoms every day, and with purely software applications there is no way to do that," Dragon Innovation's Miller said. "You need hardware to get meaningful data."

Catalysts such as the smartphone boom, and other advancements that reduce the cost of launching a company make the ventures less risky, experts said.

Renee DiResta, an investor at the early-stage VC firm O'Reilly AlphaTech Ventures, said that hardware companies have faced significant challenges and risks—from building a prototype and inventory management, to developing market demand and finding a factory.

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"Before, when you came in without a prototype and you had to make a minimum of 500 units before any factory would even commit to the product, VCs would weigh the risk and not want to take you on," DiResta said.

Now, she said, "entrepreneurs are coming in and presenting a prototype that they 3-D-printed or they have successfully demonstrated a market for their widget on a platform like Kickstarter...The bigger idea is more reasonable for a VC to take on."

And VCs are definitely taking on more hardware ventures.

Kleiner Perkins Caufield & Byers, Google Ventures, LightSpeed Venture Partners, and Shasta Ventures are all investors in Nest Labs, the maker of a smart thermostat.

The Foundry Group has invested in a slew of hardware companies, including MakerBot, a maker of 3-D printers; FitBit, which produces wireless activity trackers; and Sifteo, which builds interactive gaming cubes.

O'Reilly AlphaTech's hardware investments include 3D Robotics, a maker of unmanned drones; and Misfit Wearables, which makes connected fitness trackers.

Andreessen Horowitz, which is already invested in the 3-D printing company Shapeways, plans to expand its presence in the space, said Chris Dixon, a partner at Andreessen Horowitz at TechCrunch Disrupt last month.

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"I think you will see a bunch of hardware investments from us that will include software, but will also be a hardware component," Dixon said. "Hardware is a huge space, everything from wearable computing to robotics, a lot of interesting stuff both on the consumer and industrial side."

But less risk for VC investors doesn't mean less risk for the hardware companies themselves. There are still a lot of challenges, including scaling production and supply chain management, so businesses need to be selective about their partners.

"There are a handful of VCs waking up to this trend, and it's important if you are an entrepreneur that you work with a VC that has worked with a hardware company before," Vassallo of Kleiner Perkins said.

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While the software side has long had incubators and accelerators to help get companies off the ground, some hardware-focused accelerators hoping to fill the void in that space.

Bolt, a Boston-based hardware accelerator, launched earlier this year and plans to have its first program in June. It's headed by Ben Einstein, who has a background in design at Brainstream; Miller; and Axel Bichara, a venture capitalist who spent 19 years at Atlas Venture.

"Much of what's going on is a leveling out of software companies and hardware companies," Einstein said. "It used to be that software had a strong upper hand because it took a longer time to launch a hardware company and because of the way software companies can grow quickly, it made hardware look unattractive, but that's not the case anymore."

Bolt is selecting applicants for its six-month program, which will provide start-ups with necessary tools (such as professional 3-D printers) and expertise.

While public companies have dropped the ball on innovation, start-ups are busy creating the next game-changer and are primed for growth, Miller of Dragon Innovation said.

"If you look at Apple, they have done great stuff, but it's the same stuff with a new form factor," he said. "For us, companies on the edge, that is where the heartbeat is. Apple isn't going to triple in size, where say, Makerbot, which we have been working with for a few years, has gone from two people and to two hundred people."

In addition to seed capital, accepted applicants will receive discounted services from companies including AT&T, Stratasys, Proto Labs, and Microsoft, as well as lines of credit and access to angel investors and mentors.

Others, including PCH International and Lemnos Labs, are doing similar things to evaluate the risk and focus on creating the best template for hardware companies to launch and grow, DiResta of O'Reilly AlphaTech Ventures said.

Hardware's revival can also be attributed to a desire for the tangible, she said.

"There is something that's really appealing about hardware. When someone says download this app, there's really only so much you can get excited about," DiResta said. "But when you see someone in the park with a flying robot, people want to know more about it. People are drawn to physical things."

—By CNBC's Cadie Thompson. Follow her on Twitter @CadieThompson.