Venture capitalist explains new rules for IC startups

So suggests William Quigley, managing director at Clearstone Venture Partners (Menlo Park, Calif.). "We see 2003 as a sluggish year, and we basically have no visibility into 2004," he said. "So, lacking anything to the contra ry, we assume that 2004 will bring a return to reasonable conditions for the electronics industry."

That timing, Quigley explained, is great news for some companies and dire news for others. "There is definite activity in funding early-stage companies," he said. "These are companies who, if they get started now, will have their chip completed just about in time to catch the 2004 recovery, should it occur."

But for older startups the outlook is far darker. "The older companies tend to have taken a huge amount of money in their early rounds, back during the bubble. They have burned through that and are now sitting on untenable leases.

"Worse, their technology is old now," Quigley said. "It matured when there was no market, and so they have never been able to ship anything. Even a socket win without any volume is worthless today. So to get another round of funding, these older companies would have to go out and compete against companies with much more recent designs for sockets that wil l actually result in shipments."

Thousands of failures

To emphasize the seriousness of the situation, Quigley estimated that the number of failing ventures in the coming year could reach the thousands. "It will be painful, but it's probable that most of these investments have already been written down in their investors' portfolios," he said.

In particular Quigley pointed to the coming debacle in the 802.11 system-on-chip sector. "You've got maybe 50 or 60 multimode chip designs out there, all chasing one market. Granted, that market will have some attractive volume, but not that much. These guys don't have a prayer. It's in some respects like the situation in network processors."

So is there any hope? Definitely yes, Quigley maintained. But the rules for successful new ventures would be very different than in the bubble days.

To start with, Clearstone doesn't just fund neat ideas or hot design teams. Rather, the company, like many experienced investment te ams today, systematically looks for end-user markets with significant volume potential and significant entry barriers in the time frame in which the startup could realistically complete a design. That means, for example, that Quigley is moderately interested in some aspects of consumer electronics and networking, and not particularly excited about optical communications.

"In optical, you have Nortel and Lucent with several years of inventory on hand," he observed. "But in some other areas, where the end-customer needs are shifting, the inventory on hand is sitting there growing obsolete. It will have to be replaced."

There will not be much more blue-sky investing in chip startups, Quigley predicted. For one thing, venture capital firms are syndicated now, and they tend to watch how many ideas have been funded in a given area. "If you are not one of the first four companies to get funded, you are going to have to be something really special to get any interest," Quigley said.

Further, having been once burned, most venture funds not only conduct careful investigations of the proposed team but also undertake due diligence on their proposed market. The days when you could pass off a list of founders as a business plan are long gone.

Finally, with risks now better appreciated and with design costs spiraling, Quigley said that the new-venture investments would have clear strategies not just for launching a design effort but for carrying a company through to volume production. "You can't assume that anyone but insiders will be in for subsequent rounds," he said. "In that regard, venture investing is starting to look like the leveraged-buyout market. The investment has to have a path all the way to break-even, not just to Series B."

Outsourcing necessary

Part of that plan, Quigley said, is much more active involvement in how the design is conducted and, specifically, how much it costs. The problem is not the much-touted million-dollar mask set but the whole des ign cost.

It is commonly estimated that the total design cost for a 130-nanometer system-on-chip will be in the neighborhood of $20 million. That won't cut it, according to Quigley. And the key to beating that number is design outsourcing.

"We don't fund chip designs that don't outsource to India," Quigley stated flatly. If you rely on Indian contractors for the things they do well, you can get a chip out for under $10 million. If you don't, you can't, and you won't be competitive. It's that simple. Even major Japanese semiconductor players, Quigley said, are starting to use the Indian shops.

"That means that we can possibly hit break-even with a company for a total investment of $25 million," Quigley said. "That is an attractive enough possibility to make us quite determined about this.

"We like to see a design team that has experience with outsourcing significant parts of the design. We like to see a vice president of engineering who has existing relationships with Indian c ontractors. There's a set of skills there that is, we feel, necessary for success now."

There, in Quigley's view, is the new environment. Investors now expect to be with a company until volume production.