Solarflare, Level 5 Get the Merge Urge

In one of the stranger deals to cross the wire lately, two 10-Gbit/s Ethernet startups are joining forces in a merger of equals, creating a vertically integrated card manufacturer.

Solarflare Communications Inc. , which is developing physical-layer chips for 10-Gbit/s Ethernet over copper, and Level 5 Networks Inc. , a startup making Ethernet network-interface cards (NICs), are being mashed together with the blessing of their venture-capital backers, including common investor Oak Investment Partners .

The combined company will retain the "SolarFlare" name, and SolarFlare's Southern California home will be the headquarters, while Level 5 keep its homes in Sunnyvale, Calif., and Cambridge in the U.K.

Semantically, at least, the deal is a merger rather than an acquisition, as no money or shares are changing hands between the companies, and the combined company intends to sell each side's products. Their combined investors are tossing in a funding round as a wedding gift.

The companies aren't saying what their funding gift is, but the extra dough brings the merged company's cash total to more than $50 million, says Russell Stern, CEO of SolarFlare (both the original and the post-merger version).

Sources around Silicon Valley say this kind of deal usually indicates something's gone wrong. Often one of the companies is running out of rope, and an investor gloms it onto another startup in hopes of keeping things afloat longer.

Bandal Carano, the Oak partner who's on the boards of Level 5 and SolarFlare, insists that's not the case. Carano says he and other investors are enthusiastic for the deal.

Still, some suspicious glances will head SolarFlare's way. The chip startup has raised $78 million since 2001 -- including a hefty round last year -- but still isn't shipping chips. (See Solarflare Raises $48M.) Meanwhile, competition is brewing from other startups such as Aquantia Corp. , ClariPhy Communications Inc. , and KeyEye Communications Inc. , to name just a few. (See Aquantia Gets out of the 10-Gig Gate, ClariPhy Targets 10 Gbit/s, and 10-GigE Copper Heats Up.)

Level 5 has raised $39 million since being founded in 2002, most of that money arriving in a $30 million round last June. (See Level 5 Launches.) Unlike SolarFlare, the company says it's started shipping. But its CEO, Dan Karr, left last year -- the fact that Level 5 was seeking a CEO was one factor that helped drive the merger, Stern notes. (Level 5's founder and CTO, Steve Pope, will share CTO duties alongside George Zimmerman of old-school Solarflare.)

Stern, who joined SolarFlare in 2004, says the impetus for the deal wasn't desperation, but a decision that Level 5's NIC was an ideal vehicle for pushing 10-Gbit/s Ethernet ubiquity.

"The Level 5 approach to the problem maintains perfect Ethernet standard compatibility, whereas many of the other technologies need to be tacked on both ends of the wire," Stern says. Easy plug-and-play options are most likely to be successful in Ethernet, he reasoned, meaning Level 5 had a good chance of standing out.

Of course, the deal also gives the old SolarFlare a shortcut to some revenues while providing some potential savings. "It allows us to spread our overhead over more products, and it gives us more products to sell," Stern says.

Stern says he devised the idea for the merger late last year and fleshed it out with Carano's help. The two then took the concept to investors of both companies, winning, according to Stern, unanimous approval.

That might have been the easy part. "It was a difficult structural deal, because you've got a U.K. entity and two California entities. You had lawyers on lawyers."

In addition to Oak, the other investors involved include Anthem Venture Partners , Foundation Capital , Intel Capital , Miramar Venture Partners , and Windward Ventures on SolarFlare's side; and Accel Partners , Amadeus Capital Partners Ltd. , and IDG Ventures Europe on Level 5's side.

— Craig Matsumoto, Senior Editor, Light Reading