In the previous article (https://www.tdshepherd.com/the-art-of-services-foundation-strategy/) we explained that design services companies often start as a spin-off from universities: Masters and/or PhD students research next generation semiconductor functions and, upon publications of their work (thank you IEEE), they get approached by companies interested in incorporating the new technology into their product roadmap. Sometimes this results in a hire, sometimes the engineer in question decides he/she would like to remain independent and start a business, usually taking along a few fellow students. Incubators [attached to the university] should have a keen interest in such design services companies. Often, such incubators look for VC-driven startups, startups with focus on products and hence offering a solid multiple on their investment. Design services companies do not attract venture capital because they don’t offer the multiples required by such funds. However, design services companies are essential ingredients of a healthy eco-system and, often enough, also function as a springboard for the next fabless semiconductor product company.
What is important for a starting design services company to look for when incorporating?
Following are key parts of the setup:
(1) at least one customer contract that will cover you for the next 9 to 12 months (financial continuity);
(2) an established strategy, market and customer segmentation (compass and route);
(3) at least a team of three to five dedicated engineers (critical mass);
(4) access to EDA tools (probably the most expensive part of your setup)
(5) transfer of patents and patent applications from the university to the newly founded company (freedom to operate);
(6) knowledgeable CFO as a part-time MT member (proper financial management and strategy).
Of course, there are more parts to consider but the six listed are key boxes to tick. Over our time as corporate strategy advisors we have seen and are seeing a lot of different companies in the service business, as growth companies looking for acquisition targets, as potential acquisition targets or as companies we advise as part of their long-term strategy. Ensuring a proper foundation is key to building a solid house.
One of the challenges that comes with design services is the cyclical nature of the services business. When the economy tightens and corporates are watching their operational expenses, the first step will be to halt any external contracts/contractors which are not deemed absolutely essential.
Whereas the earlier (staircase) model is a good approach in scaling up revenue and creating new revenue streams, the foundation of the company is still based on the service model: headcount continues to be the main driver (typically up to 60-70% of revenue). In terms of (enterprise) valuation the additional revenue streams, however, will already make a significant difference.
Design services companies typically start small (some exceptions when it concerns management buy-outs) and natural growth is a slow process as it requires hiring and training of engineers based on/driven by the revenue stream of the company. Growth of business is tied to growing the team and it is not always easy to find the engineers.