Command line millionaires

• Article 7 of 16
• LinuxUser & Developer, November 2005

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I have this great scheme. It’s going to make as both rich. Millionaires, in fact: multi-millionaires to the tune of $100 million, maybe more. Interested? Okay, it’s going to take time, maybe three years and it’s going to need a lot of preparation. So if you’re going to be in on this, I’m going to need a deposit. Say $3 million? Are you in?

It sounds like a scam. Variations on it separate fools from their money in Vegas every day. To buy into it, you’d need some pretty big assurances that the scheme was legitimate and was actually going to work.

Welcome to the world of venture capitalism. Venture capitalists (VCs) are the usual first stop for technologists in need of large amounts of money. Increasingly, companies that use open source software as the basis for their products and services are turning to VCs as well in the hope of being the next Red Hat or JBoss.

But do VCs “get” open source? Can an open source company do business with the men in suits without losing their souls? To find out, for this, the third in a series of articles on open source business, we spoke to a number of VCs around Europe and the US that had chosen to invest in open source companies about their motivations, their attitude to open source in general and whether they attempted to change the companies in which they invested.

Open source has been on the radar of most technology VCs since 1997, particularly in the US. Impressed by Linux’s ability to undermine the standard operating system sales model, it was the advance up the stack of open source from infrastructure to middleware and now to applications that is convincing VCs that open source is an area they need to be investing in.

The motivation for investing in open source companies is profit, although some have higher aspirations. “We are primarily interested in making money, although we do have limits and we try not to be bad guys and force people to do things,” says David Skok of the US-based Matrix Partners, one of the firms that invested in JBoss during its first round of funding in 2004.

Skok, like other VCs, is convinced that open source is going to take over many areas of the software business, making it a more than worthwhile investment. Deborah Magid is director, strategic alliances, at IBM’s venture capital group says the evidence for that is clear. “Open source is hot. It’s just about impossible to buy a company that does not have open source inside its products. It’s become so mainstream, we assume if a start-up comes to us, it’s using open source somewhere. VCs tell us that all the new business plans coming to them say they’re using open source and it’s now so compelling, they [proactively] ask start-ups how they’ll use it.” Some VCs are going even further. “Literally, they will go through Sourceforge and look for projects that might make decent commercial ventures. They either find the key contributor or some other entrepreneur who can build a company around that.”

According to Peter Fenton of Accel Partners, which has invested in open source companies such as Xensource, JBoss and Zimbra, the hope is to find the company that will be a brand name in five or ten years, rather than the company that gets acquired and you never hear from again. Making money is just a by-product of having found the best entrepreneur in a market with critical mass. We don’t go into this with an avaricious sense.”

VCs do have quality thresholds, however: they aren’t looking to invest in just any open source company. They’re mostly looking for two things. The first requirement is a product with a community of developers and users around it. Unlike proprietary software, which will usually need VC funding to get it to the point where it can be released, open source software’s main virtue for VCs is the word-of-mouth and momentum that a community will have already provided.

Says Shoke, “The big thing about open source is that it allows you to lower the cost of sales and marketing so you can operate far more cheaply than in a traditional software business. Open source has to have a very large community otherwise that dynamic doesn’t work. A lot of open source companies are coming in and saying, ‘Please fund us’. I look at them and say ‘Come back, when you’ve proven you’ve got a community. Otherwise, you’re going to have to go through the same long sales cycle as proprietary software, but you’re never going to make as much money as the proprietary company.’”

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