Capital-lite funding may be just what the semiconductor industry needs. Here's how it works.
Silicon Valley needs a drastic revitalization of its founding semiconductor industry -- the industry that transformed the region from a major fruit grower to the world's premier high-tech ecosystem.
Investments in fabless semiconductor startups have been steadily decreasing in both number and dollars since 2000. There are two primary reasons why total investments and investment dollars have dropped off in that time, which happen to be the same two reasons why software startups are popping up like corn kernels on a hot stove.
- The number of M&A exits dropped precipitously since a high in 2000 with a little over 120 acquisitions to a low in 2009 of just over 40.
- Similarly, the number of IPOs has dropped from about 26 in 2000 to none in 2002, 2008, and 2009. Last year, fewer than five fabless semiconductor companies went public.
Summarizing those two reasons, it can be said that the exits for fabless semiconductor companies are becoming both harder to come by and less lucrative. The mass consolidation in the semiconductor industry has led to fewer companies in a position to acquire. The turmoil in the financial markets has reduced the number of IPOs generally, but particularly in the semiconductor space. Moreover, the meteoric rise of much-lighter VC-funded or "capital lite" opportunities in the consumer software space attracted both the investment dollars and the entrepreneurial talent.
With limited exit options, venture capitalists and other investors are drawn to the higher and faster returns of software companies. The semiconductor industry has largely been abandoned by all except the most ardent believers.
As servers and even networks increasingly become virtualized, even the brightest minds forget that virtual machines exist only if there is a hardware platform and physical network on which to run. China and India continually pour resources into semiconductor R&D, design, and manufacturing. Companies in Taiwan are increasing their efforts to recruit the best and brightest from the Silicon Valley. While this doesn't yet rise to the level of a brain-drain, it's a model that's not sustainable if we hope to retain our leadership position in semiconductors and enterprise hardware.
The Global Semiconductor Alliance (GSA) addresses these issues by proposing a concept: a "capital-lite" structure for semiconductors. Silicon Valley's traditional VCs, company-owned strategic VC firms, and other members of the funding community need to take inspiration from the GSA concept and turn it into a new model for funding the semiconductor industry. We at SKTA Innopartners embrace the concept and are implementing many aspects of the GSA model in our incubation and seed-funding arm through our VC organization.
The key aspect of the GSA model is pairing a startup with a strategic partner at the earliest possible time. The strategic partner should be an industry leader who has interest in the startup's solution to either fill a product portfolio gap or enter a new market. For optimum success, the startup should ideally be housed in an accelerator and provided funding through proof of concept and support through the seed phase. As an example, SKTA Innopartners provides any back office or logistical support to the startup so that the startup can focus on the primary task of product development.
At the conclusion of the seed phase, it is beneficial that the strategic partner, bold VCs, and the startup negotiate the startup phase of the startup. At this time, milestones should be set as well as the exit valuation, depending on the milestones achieved.
At the conclusion of the startup phase, the strategic partner should be able to exercise a call option to acquire the company at the predetermined exit valuation. If the strategic partner chooses not to exercise the call option, the startup should be free to shop for other potential acquirers, additional VC funding, or decide to go it alone. After six months, the startup should be able to exercise a put option for the strategic partner to acquire the startup.
This model can lead to a re-energized semiconductor environment. Using this model, the startup gets guidance from a strategic partner regarding customer requirements and technical best-practices; funding, facilities, and professional services; and a guaranteed exit. The strategic partner is able to fill a product portfolio gap or enter a new market faster than with an internal development and at a lower cost than a traditional acquisition.
Venture capitalists are able to participate in largely de-risked deals with a much shorter time-to-money. Properly executed, this model drastically shortens development times and increases the number of entrepreneurial pipe-dreams that become industry creating innovations. It's a win-win for the Silicon Valley semiconductor industry.
— Angel Orrantia is Director of Business Development at SKTA InnoPartners LLC.