Recently I discussed the challenges in today's financial climate with semiconductor startups and valuations relative to capitalization at liquidity.
In spite of these issues there are still opportunities within the technology industry, but how does one qualify a startup to determine whether or not it's worth investing the sweat equity required to succeed financially?
There are five basic criteria any startup requires to help ensure a high probability of success.
Rule #1: Evaluate the dollar size of the potential market the startup addresses. In the marketing world this is referred to as the total available market (TAM). It only makes sense that the larger the market a company can address, the greater the company's potential value. But how big does it need to be? This depends on the business and the capital expenditure (capex) costs to get to liquidity. In the semiconductor space, capex at liquidity is typically in the $100 million-plus range and investors typically expect a significant (3x to 10x depending on series) multiple over capex. Given today's multiples in the public market to value the company and reasonable assumptions about how much a company can expect to address of any given market, the TAM needs to be well in excess of a billion dollars to even be worth considering.
Rule #2: Check for oncoming market discontinuities. An example would be the conversion from standard definition (SD) to high definition (HD) broadcast TV. The startup must be able to offer customers something truly needed by virtue of a significant transition within the market it addresses. Trying to displace an incumbent with a cheaper, faster or lower-power solution, for example, is very difficult. Typically technology incumbents are slow to cannibalize their positions/products, and market discontinuities create "pain" for customers and a strong demand for a new entrant. A discontinuity gives Davids a chance to participate in a market Goliaths typically dominate.
Rule #3: Timing is everything. We've all heard that expression, and it couldn't be truer than in the technology startup game. The timing of when the market needs a solution and the development time of the solution must generally align. Examples of startups that were too early are the Bluetooth and Ultra-wideband semiconductor startups that began work on products in several cases years in advance of standards or ecosystem maturation. If you are too early you burn excess cash and become overcapitalized. If you are too late competitors are more likely to fill market needs, even with inferior products. Typically, products that are "good enough" win vs. products that are "the best" technically.
Rule #4: Be sure there's a clear path to revenue. The company needs total control of selling and deliving its product directly to the customer. It must be able to avoid having to work with partners or other solution providers to enable its first product sales. Many people think being partnered with large, established players is a good thing but more often than not the big players slow you down, or in many cases change their minds and discontinue the partnership. If the company is dependent on others to get to first revenues it becomes precarious. Be wary of anything that requires ecosystem development, standards or industry consortia, as typically these are slow to develop and can be controlled by larger players that have economic strength to manipulate a long-term strategic outcome in their favor--and to the startup's detriment.
Rule #5: Confirm that the core team will be able to execute. In every startup, execution is 80 percent of the challenge. Clearly teams that have "been there, done that"--in another startup or in an established organization--are more credible than those that have not. Avoid teams that are purely technology driven or that believe technology above all other assets and skills will succeed. It takes a well-rounded and balanced set of technology, product development, operations and marketing/sales skills within the core team to succeed.
If you choose to participate in a startup that has been measured against and meets all five of these rules, then take a sniff. That's the sweat equity drying into the sweet smell of success.