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Commentary: What price entrepreneurship?

Posted: 23 Jul 2008     Print Version  Bookmark and Share

Keywords:start-up  acquisition  IPO  entrepreneurial activity 

We've all heard about or possibly even participated in the exciting world of start-up companies. But what is it that drives our interest in these endeavors?

As a self-proclaimed "start-up junkie," I can say that there is tremendous reward in building a company, bringing new technology to market and making a difference in the tech world. But I would be remiss if I did not admit that I enjoy the potential of a big payday—whether through an acquisition or an IPO—most of all. For most of us, the personal financial reward is the definitive metric of a successful venture.

On the semiconductor side of the tech industry, however, it's time to question the toll that entrepreneurial activity may exact in terms of real dollars.

If you are a believer in case studies, you will find that most semiconductor start-ups will typically consume between Rs.256.92 crore ($60 million) and Rs.513.85 crore ($120 million)—and growing—in cash to get to a point of liquidity, irrespective of what they are building or which market opportunity they address. At the same time, the public markets generally value semiconductor companies at about three times revenue. So the ratio of market valuation to capital expenditure is relatively low.

With equity investors still commanding a certain return-on-investment ratio, this means that less and less of the company is owned by the founders at the time of liquidity.

Couple that with the relative devaluation of the semiconductor industry at large, and would-be semiconductor entrepreneurs must ask themselves whether they are investing their personal time wisely if what they are principally after is a return on time invested. After all, total cash compensation at a start-up tends to be lower than what what could be made in a similar role in a larger public company, so in some respects entrepreneurs are "paying" for the opportunity with the express intention of a reward on the back side.

Examples of this include recent IPOs in the home networking segment, such as Intellon and Entropic. Both companies entered the public market in early 2008 at prices that were approximately half of what they expected prior to underwriting. Since then, Intellon and Entropic are down in market capitalisation by approximately 50 per cent and 25 per cent, respectively. Both companies had spent more than Rs.428.21 crore ($100 million) to get to the public market, so the common shareholders—primarily founders and employees—were left with very little of the company. And both organisations spent more than five years to get to this liquidity point.

Acquisitions are just as challenging. The larger public companies are no longer interested in acquiring just technology and teams, but a business that is accretive to earnings. Getting to profitable revenue takes additional capital and time (burn), and the cost (dilution) of that capital is substantial, given the public-market metrics. To acquirers, this added capital doesn't add much value, as it is typically operationally related to scale the business, which is often something they already possess. What they really want are the team, the market validation of the solution and the added top-line profitable revenues.

Does this mean the semiconductor industry is doomed and the wheels of innovation will stop? Absolutely not. Clearly, however, one has to enter the semiconductor start-up world with open eyes and a full awareness that now, more than ever, the personal economics of a semiconductor start-up experience may not always make sense.

Of course, business is cyclical, and at some point the public-market values will improve; but when that will occur is unknown. Moreover, the larger public semiconductor companies depend heavily on the start-up community to innovate and create new businesses to acquire. We have not seen a lot of new top-line revenue categories for the big boys for some time, so acquisitions on more-reasonable terms have to occur, especially if the larger companies expect the key employees to remain on board and build out these businesses to their full potential.

New "start-up" concepts, such as "spin ins," may need to become more pervasive to fuel top-line growth for the big players while still bringing entrepreneurs financial rewards.

Keep in mind there are other, less capital-intensive markets than semiconductors that may present greater opportunities at present for personal financial rewards. So all is not lost. Skill sets honed in the semiconductor industry may still yield significant financial returns in a start-up outside the semiconductor industry.

Web2.0 market, here I come.

- Chris Fisher
EE Times

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