I am a member of the Global Semiconductor Association (GSA) and was asked to write a commentary on the current state of VC funding of the sector for their June 2010 newsletter. If you are a startup or established company in the semiconductor ecosystem, you should absolutely join the GSA, as the member benefits including industry data and networking are priceless.

Here is my piece:

Looking at 2010 as an optimist, the semiconductor sector is coming back. Public companies’ earnings are up, excess fab

capacity has dwindled and, finally, we have seen a return of the IPO market, with four in the air already and eight others

on the tarmac awaiting liftoff. And GSA reports that in the first six months of 2010, 78 semiconductor funding deals were valued at approximately $800 million, a respectable 42% increase over the same period in 2009.

But beneath this high-level news is data that continues to be discouraging to entrepreneurs and early-stage investors (like yours truly) who are seeking to fund them. Of the companies funded in 1H 2010, only four look like de novo start-ups, meaning that the remaining are running companies raising follow-on rounds. So we’re still in a drought for venture-funded start-up semiconductor companies. As one of the few, but proud, investors targeting this sector, I think I have an explanation as to why.

First, there is a supply problem. We’re not seeing enough innovative ideas. Innovation doesn’t only mean focusing on new markets such as solar, LEDs and sensors. Personally, I am a huge fan of taking on complacent incumbents by reinventing vectors where they have reached technology or business model barriers. I invite entrepreneurs to reach out and describe why a big portion of their favorite, large public semiconductor company’s business is ripe for the taking.

Second, there is a business model problem. It is very expensive for a semiconductor company to reach “standalone status.” If it takes nearly $100 million in capital to finance company XYZ and breakeven, and the market for acquisition of said company ranges from $75 to $100 million, the equation doesn’t solve. So in addition to closing the gap, entrepreneurs need to be able to demonstrate how they can effectively operate on fewer dollars. I have seen and funded several different companies in the past few years that have done this in a few different ways: utilizing older geometries and cheaper materials, being a player in the microelectromechanical systems (MEMS) and analog/mixed-signal markets, and leveraging third-party technology. And I am sure there are others.

Third, there is a venture capital problem. There are too few VCs interested in funding semiconductor companies. The

returns have been terrible across all venture-funded sectors; however, to be blunt, semiconductors have created deeper

holes than others. Semiconductor investment is harder than software investment because it adds complex manufacturing

issues to many of the same risks faced by software companies such as reliability, customer concentration and intensity of incumbent power. Combine poor outcomes with huge capital losses and complicated technology that is often hard to get right the first time and you will lose investors – even the bold ones.

However, I see tremendous opportunity for entrepreneurs and VCs ready to take the leap. The semiconductor industry

may very well be at a discontinuous moment, but it is also the very best time to start new competition. Incumbents have underinvested because of the great recession of 2009, and many of them are overconfident about their clout with

customers. Matched with the maturity of the fabless value chain, customers are far less reluctant to work with start-ups. Gaps and new markets exist, engineers and business talent are eager for new challenges, and the best ideas, no matter how seemingly cold a market, always get funded. So let’s be optimists!