Technology, Media & Healthcare

How to Underwrite a Hardware or IoT Company

Underwrite a hardware or IoT company by separating one-time device revenue from recurring software and service revenue, then testing supply chain, inventory and warranty exposure. Key metrics are hardware gross margin, attach rate and retention of recurring subscriptions, inventory turns, and warranty and return rates. Recurring revenue on an installed base drives value; inventory and supply chain drive risk.

What makes hardware / iot underwriting different

Hardware and IoT companies sell physical devices, often paired with software subscriptions, connectivity or monitoring services. Value comes from the installed base: each device sold can generate recurring revenue for years, and integration into customer operations creates switching costs. Risk comes from the physical side of the business: component shortages, dependence on a contract manufacturer, tariffs, inventory that becomes obsolete with each product generation, warranty claims and returns. Working capital needs are heavy because the company must pay for components and finished goods long before customers pay. Product launches can slip, and a single design flaw can lead to costly recalls.

Lenders view hardware companies as working capital credits and underwrite receivables and inventory like other product businesses, with conservative advance rates on finished goods and minimal value for components. Recurring revenue, if meaningful, can support additional term debt. Equity investors underwrite the installed base and the economics of the recurring layer: attach rates, subscription retention and lifetime value relative to hardware subsidies. They pay more for companies where software and services drive gross profit and where hardware is a distribution channel rather than the main profit source.

Key metrics

Hardware gross margin

Device margins must cover component costs, manufacturing, freight, tariffs and warranty, and can fall quickly with supply shocks.

Recurring revenue attach rate

The share of devices with active subscriptions shows how well the installed base is monetized.

Subscription retention

Recurring revenue only has value if customers keep paying after the initial term.

Inventory turns and obsolescence

Long lead times force forward purchasing, and inventory can become obsolete with new product generations.

Warranty and return rates

Defects drive replacement costs, returns and reputational damage that affect future sales.

Supplier and contract manufacturer concentration

Single-source components or one contract manufacturer can halt production.

How to underwrite it, step by step

Split revenue and gross margin into hardware, subscription, connectivity and services.
Analyze installed base, attach rates and subscription cohort retention.
Review bill of materials, single-source components, lead times and supplier contracts.
Diligence the contract manufacturer agreement, quality controls, capacity and location risk.
Analyze inventory aging, purchase commitments and excess and obsolete reserves.
Review warranty claims, returns, field failure rates and product certifications.
Assess tariff exposure and the impact of supply chain disruptions on margins.
Size working capital facilities on eligible receivables and inventory, and stress test supply and demand shocks.

Due diligence checklist

Revenue and gross margin by hardware and recurring streams
Installed base and subscription cohort data
Bill of materials with supplier and lead time detail
Contract manufacturer and supply agreements
Purchase commitments and non-cancelable orders
Inventory aging and reserve analysis
Warranty, return and field failure reports
Product certifications such as FCC, UL or CE
Tariff classification and country of origin analysis
Firmware security assessments
Patent portfolio and freedom to operate analysis

Key risks and mitigants

Component shortage halts production

Identify single-source parts, review buffer inventory and alternate suppliers, and stress revenue for production delays.

Inventory obsolescence

Exclude aged and prior generation inventory from borrowing base and review purchase commitments.

Warranty and recall costs

Review failure data and reserves, and confirm product liability and recall insurance.

Contract manufacturer disruption

Review contract terms, tooling ownership and qualification of a second manufacturer.

Tariff and trade policy changes

Analyze country of origin exposure and pricing pass-through, and stress margins for higher duties.

Low subscription attach or retention

Value hardware and recurring revenue separately and avoid crediting assumed attach growth.

Typical financing and deal structure

Hardware and IoT companies typically finance working capital with asset-based revolvers against receivables and eligible inventory, purchase order financing for large orders, and supply chain finance programs. Venture-backed hardware companies use venture debt alongside equity, often with tighter terms than software because of inventory and supply chain risk. Companies with meaningful recurring revenue can add recurring revenue loans. Equipment and tooling may be financed through equipment loans. Acquisitions often include earnouts tied to product launches or recurring revenue milestones. Lenders commonly require inventory field exams, appraisals and borrowing base reporting, and covenants may include minimum liquidity and limits on purchase commitments.

Red flags

Large non-cancelable purchase commitments while demand is slowing
Rising return rates or field failures after a product launch
A single-source component with no qualified alternative
Recurring revenue attach falling on new device cohorts
Hardware sold below cost to drive subscriptions without proven retention

Frequently asked questions

How do you value a hardware company with recurring revenue?

Investors typically value hardware and recurring revenue separately. Hardware revenue is valued on lower multiples tied to gross margin and growth, while recurring subscription revenue is valued on software-like multiples if retention is strong. The installed base and attach rate determine how much recurring revenue future device sales will generate.

What financing options exist for hardware startups?

Hardware startups commonly use venture equity, venture debt, purchase order financing, inventory financing and asset-based revolvers. Purchase order financing funds production for confirmed orders, while asset-based facilities lend against receivables and inventory. Recurring revenue loans become available once subscription revenue is substantial. Each option carries different costs and reporting requirements, so many companies combine them as they scale.

How do lenders treat inventory at a hardware company?

Lenders advance against finished goods at conservative rates based on appraised liquidation values, often giving little or no value to components and work in process. Prior generation and aged inventory is usually ineligible. Field exams and periodic appraisals verify inventory quantity and value. Purchase commitments that are not yet delivered are also reviewed because they can create future obligations.

Why do hardware companies need so much working capital?

Component lead times force companies to buy materials and pay manufacturers months before selling finished products. Customers, especially retailers and enterprises, often pay on extended terms. This gap between cash out and cash in requires financing, and it grows as the company scales. Underwriters size revolvers to cover this cycle and stress it for supplier delays.

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Educational content, not investment, credit, legal or tax advice. Benchmarks are common practitioner rules of thumb and vary by lender, market and cycle.