October 23, 2012

Jasper CEO talks EDA success

10/23/2012 10:31 AM EDT

I sat down with one of the most well-known and influential CEOs in the EDA industry – Kathyrn Kranen, the President and CEO of Jasper Design Automation. Kathryn is responsible for leading Jasper’s team in successfully bringing their technology to the mainstream design verification market. She has 20 years EDA industry experience and a proven management track record. While serving as president and CEO of Verisity Design, Inc., Kathryn and her team created an entirely new market that we now call design verification.

The discussion went far and wide and if you know Kathryn, she manages to pack a lot into a short space of time, so this is both abridged and will be published in several pieces.

It seems to me as if the fundamental business model for EDA has changed in the past 10 years or so. We used to see startups do the research and development and as soon as they had a customer or two, they were acquired by one of the large EDA companies. Until the recent spate of large acquisitions, that appeared to have stopped. Is this a fundamental change?

Kathryn: Seven, eight or ten years ago on the heels of the big flush of funding from the 2000-2001 EDA IPOs there were a lot of small companies hoping to make it big. I think there was a drive to take the companies all the way and so we didn’t see too many IPOs at that time. But, I haven’t necessarily seen a complete halt or a very noteworthy drying up of the small company sales. Actually, I think the size threshold for a big company to acquire someone has gotten much higher because they, the big EDA companies can’t do much with three guys and some code. They don’t know where to put the acquired company in their organization if it’s that small.

Looking around at DAC this year, it just struck me how many companies there are ten or fifteen years old.

Kathryn: That is actually very true and it’s not unique to EDA. This is because the size requirements for an IPO have more than doubled.  The EDA IPOs a decade ago were by companies with trailing revenues of between $11.5M and $22M, and barely profitable if at all. Jasper has already been profitable for nine consecutive quarters, and yet that’s not enough. You have to be much larger from a revenue perspective. Given this landscape, you would expect companies to aggregate. Bigger fish acquire littler fish to accelerate growth inorganically.  One way or another, you have to get to at least twice the size these days to IPO.

In fact one of my venture investors is Foundation Capital; they were my B-round investors. Their investment in Jasper is nine years old already, and they said, hey, no worries whatsoever. Of the last several IPOs by Foundation portfolio companies, one was fourteen years old, one was twelve years old, etc. And this is true across all the industries - companies have to be bigger just to endure the cost of going public. Although the recent Jobs Act eased a lot of the reporting requirements, only time will tell whether that lowers the hurdle to IPOs. All the investment bankers will tell you, “oh it’s going to be much easier now,” but it’s not going to lower the revenue requirements very much. Since you need to be double the size, it stands to reason you’re going to be older.  High-quality VCs like mine have learned to be patient.

The other reason there are more twelve or fourteen-year-old companies, is because the technology challenges are harder now, at least in EDA. All the easy problems have been solved, as one of my board members says. You need more iterations of learning from customers, and more marketing, to grow big enough to achieve critical mass. And you need to be critical mass even to be acquired at a decent valuation, because, you’re so much easier to integrate.  I’ve had several of the big companies talk about their acquisitions, and one of them even said, “I wish all the small companies (though we’re considered one of the larger private companies now) would go aggregate themselves so that we can buy in bigger chunks.” They don’t want to buy an entity that has revenue of less than 10 million, or even less than 20 million, because it’s too hard for them to scale that business. So I think there’s a reality that the industry is more mature. Every decade it gets more mature, and we’re seeing that harder technologies take longer, and larger entities are more valuable and easier to integrate into huge entities.  Also, the larger the acquirers are, the larger the small companies need to be to be relevant to them.
Impact on startups

What impact is this going to have on new start-ups because it’s going to be a lot more difficult to bootstrap? And now they have to think about creating a much larger revenue base which they never really had to consider in the past.

Kathryn: You’ll hear widely varying opinions when talking to some of the successful venture capitalists and entrepreneurs in this industry. I am on one end of the spectrum, and Jim Hogan would be on the other end. Jim has said, never raise more than 5 million, bootstrap, get yourself profitable as soon as you can, build the technology, try not to build the channel, and go sell the company.  That’s the vision he has shared at the emerging company meetings for EDAC.  His point is that you want to stay skinny, and that’s valid advice.

But on the flip side of the coin, I’ve always felt that to tackle big problems, and get big revenue, you have to spend to succeed.  My two previous employers went public – one while I was there, one a year and a half after I left. And in both of those cases, we had raised north of $30M in venture capital along the way. At Jasper, we’re nine quarters profitable, bigger than my previous company a the time of its IPO, and we too have raised more than $30M.  So, I guess I’ve found the formula that works for me.

In a way, Jim Hogan and I are both saying something similar. Unless you’re going to win big, you better not raise much money. That is a very true statement. But there are those of us that go for the big win, and passionately want to conquer something harder. The cost is in market penetration, and getting the methodologies established and proliferated throughout the customer sites. It’s not just about technology. It’s about shaping business models to take brand new solutions to the mainstream.

I love a quote by one of my big customers when I was asking him about another company, a very small company that’s been around for eight or ten years and has not broken the 5 million dollar revenue mark.  He said, “the problem with most EDA start-ups – and Jasper is a rare exception because of your AE margin model - is they don’t have a credible plan to cope with success. They can’t scale. Heaven forbid, that one guy doing the experiment in one of our divisions says okay, we want to use it, we have 300 designers, what are you going to do? Most companies are too small and therefore cannot possibly cope with our decision to use them; it becomes a huge problem.”

Scalability of new methodologies is an industry problem. Because of this, I think idea to “build a tiny little company and sell off the technology” has become less popular now, with both acquirers and venture capitalists. They are looking for entities and teams that have the business acumen, as well as the technology, to sustain them to a point where there’s a lucrative exit, which would either be an IPO or later-stage acquisition, once they’ve established true market success.

Maybe there are going to be three tiers of companies now. There’ll be the big acquirers, and then there’ll be the medium-sized, let’s call them IPO-plausible, or IPO-capable companies, that are still private but profitable and generating cash, and they might become the acquirers of the really small ones, the third tier.                                                         

Whether those mid-sized companies grow organically, or inorganically by acquiring others, up to IPO-state, or whether they themselves get acquired depends on the situation. Most of my advisors say, if you think you’re planning on getting acquired, you’re actually planning on failing, and you better plan to succeed and go all the way, remaining stand-alone. And if something happens along the way, if an acquirer makes an offer you can’t refuse, and if it’s good for your customers and good for your employees, then maybe you take it. But, you can’t plan on that.

That does actually bring me nicely to one of the other points that you said: the whole notion of the middle aggregating itself. How easy is that for private companies?

Kathryn: It’s extremely hard because you have a lot of capitalization table issues to reconcile, with two sets of VCs and two different boards. You have to be able to deal with shareholder issues. Usually, there would have to be one company that’s substantially healthier than the other – because you’re going to have to re-capitalize somewhere. Often one set of investors is going to lose money on the deal because the combined revenue stream and combined market size doesn’t even cover the paid-in capital, meaning the amount the collective VCs have invested.

The landscape of companies changes through survival of the fittest, meaning the fittest companies acquire the not-so-fit companies – or shall we say, the less-developed companies. It is very rare to see mergers of private company peers. If the companies are equal peers, you have two winners, and two leaders that have brought these companies to winning status.  It’s very difficult to marry them, culturally. Assuming they can clear the financial hurdles, mid-size private EDA companies are the ideal acquirers of small EDA companies with great people and technologies.  The smaller team gets acquired into an organization that still enjoys the fun of being private and being strategic and tackling big unknowns - taking market risks that are easier because they’re not a reporting public company.  The cultures are compatible.  The established channel of the mid-size acquirer already knows how to drive adoption, and can significantly grow the revenue from the acquired products.  This scenario can be a huge win for everyone involved.

This concludes part one of the interview. Look out for the second installment that relates to the selling habits of EDA companies in about a month.

Brian Bailey – keeping you covered

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