News and New Products

Redefining Success in EDA

By Ed Sperling -- Electronic News, 7/21/2006

Electronic News sat down to discuss what makes a successful EDA startup with Andrew Yang, chairman and CEO of Apache Design Solutions; Ho Nam, general partner at Altos Ventures; Robert Smith, chairman and CEO, Stratosphere Solutions, and Kaushik Sheth, founder and CEO of Rio Design Automation. What follows are excerpts of that conversation.

Electronic News: What defines a successful company in the EDA market?
Smith: The measure that most people use is financial success. Is the company profitable? Is it growing? And has it identified a big enough segment of the market that it can get to the point where it can go public—or does it have a lock on a technology that’s part of a bigger solution so that it will be acquired. That’s one way of looking at success. Another way is, what contribution has it made to the industry in terms of solving a fundamental problem.
Sheth: There are three things I use to measure the success of an EDA company. One aspect is what technology they are developing or what enabling technology they are developing. Will it really help the customers, or is it just one more innovation. The second thing is how it was executed. That means the team, the financing, the right advisory board—both business and technical. The third thing is an exit strategy. Will they make it with their financial model, will they go to IPO, or is an acquisition strategy.
Yang: It really depends on whether you’re measuring the success from inside the company, or whether you want to measure it five years later or 10 years later. It also can depend on how people think about the company. When you are involved in the company, the way other people always measure it is financially. We use the term financial independence. You have to go as fast as possible to be financially independent. Being profitable is the first step, but it’s not the only step because you can lose your profitability very quickly. The second step is employee independence. That means there is no single person in my company, starting with me, who can bring the company down. The third step is customer independence. There is no single customer that can take your company down. You have to be diversified and have a strong customer base. The next thing is shareholder value. We all work very hard to create passion for the shareholders and for the employees. They have to see there is an acceptable return on investment. The last thing is product legacy. In five or 10 or even 15 years, will people remember your product?
Nam: The vast majority of venture funding has moved out of the EDA space. It’s primarily seen as a niche opportunity. The conventional wisdom is that you won’t see that many more IPOs in this market. With the evolution of the venture capital markets, the whole sector has become institutionalized. Funds are much larger and they’re looking for home runs. What’s needed is capital efficiency. If you’re not going to get the $1 billion exits, you have to get that financial independence and profitability without burning a lot of capital. I would say the best option is to try to build a profitable company without any funding. Maybe you get some funding from customers or friends and family—or maybe you get some venture funding, but that’s an uphill battle.

Electronic News: Does that mean no one will invest in EDA companies?
Nam: No, but we don’t want to invest in EDA companies that burn cash. We want to invest in EDA companies that can get to profitability on less than $5 million. If we don’t see a clear path to profitability on a limited amount of capital, it’s going to be hard to justify ROI for that kind of investment. Looking at it more from a technology perspective, if you don’t bring anything customers value and you don’t have deep domain expertise in technology, it’s going to be harder to get to profitability. If you bring a lot to the table, customers want your expertise. Maybe in the beginning you’re just bootstrapping and living off consulting revenue, but if you bring something unique to the table people will hire you. Many of the greatest companies, whether it’s EDA or outside of EDA, were bootstrapped in the beginning. We’re big believers that too much money can hinder creativity and take away some of the hunger and the drive and the necessity to innovate. Too much money kills the ability to create great companies that will be remembered 10 or 15 years from now.

Electronic News: So far we have not seen much growth in the EDA market. How will this change and how do startups get into this market?
Smith: When you see growth in EDA, it’s because there’s a new set of problems. The big shifts in the market tend to occur every 10 to 12 years. If you think back to the late 1980s and early 1990s, that’s when synthesis and automated place-and-route systems came into use. There are now some huge areas of growth, such as how do you manufacture and understand what yield and performance will be once you push down below 90 nanometers. The other side is how do you conceptualize and verify a large system before spending tens of millions of dollars putting it into silicon. Some people call that ESL [electronic system-level design]. I suggest it’s even at a higher level than that. But if you look at how manufacturing talks to design, we’re seeing a lot of growth there.
Yang: For us, this is a question we have to look at all the time. We got to profitability in four years using less than $5 million in capital. After we became profitable last year, the question became, ‘What’s next?’ For a lot of small companies just getting products into the market and trying to get to profitability, they have to ask that question. Is their exit strategy an acquisition or an IPO? When you get to be a medium-sized company, this is a very important question. Are you a point-tool company or are you a platform-based company with an expertise in an area that is becoming more and more important. You also have to avoid being in an attrition war. The reason why many companies have not grown is they are getting involved in an attrition war. Customers are taking full advantage of that.
Sheth: How to raise money was an issue for us when we started this company. We took a very different approach than many other EDA startups. We went directly to Magma and Cadence and asked them what they thought about our idea. Cadence said it was a great idea because they didn’t want to get into our area. We picked a niche market where we could put together a team and focus only on that. We didn’t want VCs breathing down our necks because we really wanted to build the technology.
Nam: If you use VC money, you get the pressure to scale faster because there’s a time clock.
Sheth: Exactly, and time pressure to profitability has a much higher importance for them, at the expense of anything else. There currently is no competition for our tool because we are growing the market. We are not replacing anything. We are trying to grow the pot.

Electronic News: So is there an exit strategy there?
Sheth: Our exit strategy is to get to the profitability as soon as possible. Then we’ll see what happens.
Nam: Once you’re profitable, you can control your own destiny. That’s the key. The timing is less important once you’re profitable. But I would disagree on one point. If you raise venture funding, it will drive you to profitability faster. It will drive you to an exit faster because there’s a sense of urgency. But if you raise a lot of money, you don’t have the same sense of urgency to get to profitability. Companies that don’t figure out how to make money early in their lives won’t figure it out 10 years later. It has to be built into the DNA of the company up front. To be truly great, you need some luck along the way. But if you don’t have that discipline, you won’t even get the chance to be lucky. We’re big believers in capital efficiency and profitability. You have to be very careful about how much money you raise and who you raise it from. We don’t talk about exits. That might seem counterintuitive, because we do have to return capital to our investors at some point. But if you build good, solid companies, the exit will take care of itself at some point. Still, you have to be patient. The world is full of too many flippers. They want to build and exit. As soon as they raise money, they’re ready for an exit. I’m not just talking about the investors. Everybody wants to cash out. The only difference between your ability to build a great company and cashing out is will power, or in some cases necessity. We’ve invested in three companies that we’ve been in for 10 years. Those funds have already closed. One of the companies is doing a stock buyback. They’re generating lots of cash, so there’s no reason they can’t buy back from investors who want to get out. Public companies do that all the time. They’ll buy as much as people want to sell for a 30 times return on their initial investment.

Electronic News: That’s an interesting exit strategy. We have not seen an IPO in EDA since 2001.
Yang: You can have a $5 million company that generates $2 million in profits in a narrow market. You can also have a company that gets to $5 million the first year. Most people can’t, and that eliminates the majority. The next threshold is $10 million, then $20 million, and then $40 million and then $80 million. Six years ago you could go public with $20 million. Today, maybe it’s $40 million. You just have to work one or two more years. Why you haven’t seen that in the last six years is that it takes longer. It’s not impossible. You can’t expect a quick exit unless you tailor-make your company to be acquired by a specific vendor.
Nam: Getting to $20 million, $40 million and $80 million is an extraordinary growth rate, and it’s unlikely you’ll see that in EDA—or a lot of other sectors. That is the venture mentality, though. You want to invest in those companies.
Yang: It is possible though in EDA.
Nam: Yes, it’s possible. But we’re big believers in laying the foundation for good solid business long term. If you grow at 20 percent a year, you’ll be the largest corporation on the planet. It’s just a matter of time. No company can grow at those kinds of compound growth rates forever, though. We’re okay sacrificing short-term growth for overall success. In a flat overall market, growing at 100 percent a year is possible if you discover a new segment that’s rapidly growing. Coca Cola is in a market that isn’t growing fast, but within that sector you might have areas that are growing faster, such as energy drinks. If you can see yourself becoming a very substantial business with independence of employees, customers and investors, that’s great. Each company should have its own set of goals.
Smith: One of the challenges is that EDA is one of the most highly technical fields out there. As a company, you’re constantly chasing a moving target. I think it’s hard to look out 10 years. Maybe the proxy for that is Moore’s Law. If you look at design flows five years ago, there are huge changes today. I think that for the big EDA guys, their game now is more customer control than it is technological innovation. They’re trying to innovate, but their real focus is on customers. That’s also the reason they have to go out and acquire people. They keep talking about how they’re going to innovate from within. I don’t believe that.

Electronic News: Is the idea of what makes a successful company changing in Silicon Valley?
Sheth: Yes. That’s obvious after the 2001 downturn. People are not just waiting to get acquired and calling that a success. Now it’s building a technology, getting financial independence and getting profitability. That is the way people measure success.
Nam: It depends on the sector. In EDA, that’s true. In the Internet sector, the bubble mentality is back, which is shocking because the last crash wasn’t that long ago. But people’s memories are short. Silicon Valley has always been part of bubbles—sometimes big, sometimes small. We’re in sort of a mini bubble again. It’s hard to find office space again. It’s the get-rich quick scheme. I call it ‘Venture Lotto.’ After the crash people came to their senses and began to build companies based on fundamentals. It’s foolish for entrepreneurs to even think about playing Venture Lotto. As venture guys, there are many companies you can play. As an entrepreneur, you have to be very careful about what you get involved with because it can be a very big chunk of your life.
Yang: Everybody wants to be profitable and successful. What makes the difference is execution and your team. One thing I notice that is different from 10 years ago is the importance of going international. You have to build an international presence and set up offices around the globe. We have to be close to customers. It makes execution and running a company extremely challenging because you’re going 24 hours. You have to be ready to fly and take a lot of trips. You have to have passion for this.

Electronic News: What technology segments in EDA are going to be successful?
Smith: Definitely design for manufacturing and yield. It’s very clear the current design flow is going to have to be augmented to give designers feedback on what’s going to happen when they get these designs manufactured. The semiconductor guys are highly motivated to make this happen because they’ve invested billions of dollars in these new processes. We are seeing some customers very reluctant to move from 130 nanometers and 90 nanometers to 65 nanometers. There’s a tremendous push from the fab side to get the data and the analyses to designers so they can take advantage of these new processes.
Sheth: We always tend to think an area is overcrowded. Functional simulation or logic simulation is overcrowded or place-and-route is overcrowded. I don’t think that way. I think the area that will grow is where the most pain is. That pain is everywhere because the complexities are increasing. Where you provide efficiency and reliability and time to market, and wherever you have a real value proposition, you can enter a market.
Nam: There are great opportunities in any segment to redefine that portion of the market with significant innovation. One area I’ve been looking at since the 1980s is analog. It’s always been a black art, and there are lots of dead bodies along the way. It’s been tough to crack that nut, but I think there’s a great opportunity there. Even on the digital side, parametric physics on the design of digital circuits is growing.
Yang: There are already four place-and-route systems being used in the market, and there are two more coming from startups. It is a big market. But from a startup point of view, do you want to join the race and fight an attrition war? It’s going to require a lot of capital to enter that race. In DFM, it is a very important solution for customers going to 45 nanometers. But there are many startups claiming DFM solutions, and the big guys are very interested in that market and are leveraging what they have in DRC and implementation. On top of that, you have to find a way to charge customers. I like to solve anything that’s highly mathematical, as close as possible to silicon. That’s where I see the growth.