Much has already been written about Michael Fister’s comments about Cadence’s intentions to significantly diminish the role played by startup acquisitions in growing the company. Mike’s pronouncement does not mean that the four largest EDA companies will totally stop making acquisitions. It does mean though, that the preferred exit strategy for startups, namely acquisition, will be much more difficult to achieve. Of course Cadence is not alone in following this strategy. The reasons for this strategy are both technical and financial.

Aart de Geus explained one technical reason over three years ago when he talked about the difficulties that startups would encounter in integrating their point tool into the design flow of one of the major EDA companies. At the time that meant Cadence and Synopsys for IC design and Mentor graphics for FPGA and PC Board design. Today Magma can claim its place in the IC design space alongside the other two. It should be clear to anyone aspiring to be associated with a startup that companies never buy just technology; they buy market share, either present or potential. Of course the best way to show the potential of achieving a significant market share is to penetrate a key account of the purchasing company. The probability of penetrating a key account diminishes as the difficulty of integrating a tool into an existing design flow increases.

As system companies embrace 90 nm process technologies and below it becomes essential to establish close partnerships with both EDA companies and foundries. The number of partners directly impacts the difficulty of managing the partnership, so system companies tend to focus on an EDA provider that has both a demonstrated stability and the capacity to provide an inventory of tools that cover most, if not all, the functions required to design and implement a product. Betting on a startup is a risky proposition when a development budget gravitates around the tens of million of dollars mark, so only those new companies that can offer a real “got to have” tool can hope to join one of these partnerships. In the past we have seen many startups being acquired only to have their technology diluted or dissipated by the acquiring company. Such instances will now become rare, and the result of grave errors in judgment not strategic gamesmanship.

Ever since the first EDA company went public we have heard the lament that the financial community does not take EDA seriously. We get no respect, and frankly it is our fault. As an industry we have been dismal in our efforts to explain our technology and its importance to the electronics industry. Three recent occurrences amply explain our dismal attempts to communicate. The hottest filed in EDA is DFM that stands for Design For Manufacturing. Try to explain that to an outsider. Does it mean that before this introduction all designs were not meant to be manufactured? They obviously were, so why the choice? Marketing made another poor choice when they picked “IP” to signify reusable cores. This just at the time of the .com boom, when everyone had learned that IP stood for Internet Protocol. And finally EDAC chose “Where Electronics Begin” as the slogan for its publicity campaign. The problem is that we, the insider, understand perfectly the meaning of the slogan. But to outsiders this must come with a lengthy explanation of how electronic circuitry is designed, and how the design is transformed into a manufacturable product. Once you understand all this, you understand the key role that EDA plays; by then you have lost most, if not all of your audience. The common result is: if it takes that long to explain I do not understand it, and, if I do not understand it, I will not invest in it.

If a company wants to be considered a serious member of the Wall Street club, then it must behave like one. That means provide a credible method to assure a return in investment to the financial community. EDA companies do everything but that. Their message to investors is that all earnings must be reinvested in order to maintain technical leadership and increase market share. There are two problems with this attitude. The first and most obvious is that the market is hardly expanding and year-to-year revenue increase for the entire industry is due mostly to inflation, not market growth. Although new applications are constantly being introduced, older ones become obsolete, so the increase in revenues from new products is somewhat offset by the loss of revenues from older products. The second problem is only germane to public companies. If a company only makes enough revenues to continue to stay in business from year to year, it means that its profit model is wrong. And how viable is a company that continuously purchases new technology from outside startups? These are the problem EDA companies have with Wall Street.

It is fair at this point to ask the cardinal question: Why should the price of the stock increase, if the perceived returns to investors are, at best, minimal? The answer is, it should not. Dividends are another way to attract investors. EDA companies do not have a good enough profit margin to pay dividends. Thus, going public is becoming more difficult since the element of surprise is gone. Most investors in the stock market know enough about the EDA industry to avoid it.

The Law of Unintended Consequences

The two categories of companies directly impacted by the new EDA business environment are startups and Venture Capitalists (VCs). Most EDA startup have counted on acquisitions in order to develop a business plan that would project a return on investment high enough in a short enough time to interest VCs. As this outcome becomes the exception instead of the rule, it will be much harder to justify. VCs know how difficult it is for an EDA startup to go public and demand a stock price that will reward initial investors. The last company to do so, Magma Design Automation, required a total private investment of over $100 million before it could make its first public stock offering. Yet, the only way for a Venture Capital company to profitably exist is to invest in startups. The answer is both simple and unwelcome for the US economy: invest abroad. India, Singapore, Taiwan, and even Europe, not to mention China in the very near future, provide far better opportunities to realize a substantial profit by a public offering of stock of an EDA startup. In most cases, the regulatory environment is less demanding, the market not so controlled by institutional investors, and EDA is still seen as a promising technological field.

EDA is one of the US industries that still contribute positively to our balance of payments. When investments in EDA startups go overseas, we not only immediately impact (albeit minimally) the flow of capital in a negative manner, but we also set the environment for US design companies to have to purchase their tools from abroad, another negative flow of funds. This model does not require that the US loose its lead in creating new technology. Just like the manufacturing capabilities, we will export the means to realize the innovations of our engineers and scientists. We may “think” it here, but we will “develop” it over there.

A New EDA industry

The solution is for the big four to find a way to retain the innovators by providing an environment that not only facilitates creative thinking, but also financially compensates the originators of “patentable” inventions above the certificate on the wall and the few thousand dollar one-time payment in recognition of the breakthrough. Doing this would use profits internally and increase corporate assets, retain creative staff, diminish the legal battles over patents, and insure that the US does not inadvertently loose its leadership in EDA technology.

The solution does not leave much room for the volume of new investments provided by VCs in EDA. The development and marketing of new products generated by an internal invention require a financial model that provides venture funding from either internal corporate funds, banking institutions, or other forms of investments that do not demand the tenfold return required by VCs. On the other hand, risks are lower, thus lower returns are justified.

The new business model would result in greater growth of publicly traded EDA companies and would change their stock market profile for the better. The benefits of entering a new market or offering a new product would be less costly than through an acquisition, they would seem less dependent on outside innovation, and they might even provide greater returns to their investors by offering ways to participate in financing new developments. Let’s stop believing that the engine of science alone will keep this industry alive forever. We need technological breakthrough, but we also need innovations in our approach to the business. One without the other is a receipt for failure.

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