The Open Road

Venture capitalists have poured $3.2 billion into open-source companies since 1997, according to a new report from The 451 Group. It's about time we started delivering a return on that investment.

(Credit: The 451 Group)

In some ways, of course, this $3.2 billion investment has already been repaid several times over. The Linux Foundation, for example, estimates that that the Linux kernel is worth $10.8 billion in free research and development, and a compelling argument has been made that open-source vendors have already saved customers $60 billion in license fees they'd normally be paying.

Indeed, if you expand beyond just vendor-initiated open source, you quickly get well beyond a few billion dollars in value.

All of this is great, but VCs aren't known for the prettiness of the bows they place on their Christmas presents. They're investing to make a return for themselves, not enterprise IT or developing economies. With few exceptions--including Red Hat, Suse, XenSource, Zimbra, and JBoss--the open-source ecosystem hasn't been fattening the coffers of VCs.

This must change.

I believe we're on the cusp of that change. Here's why:

Alfresco Sales vs. DJIA

(Credit: Matt Asay/CNET)

For my company's last management meeting, I tracked our sales against the Dow Jones Industrial Average since November 2005, when we first started selling our product. As can be seen above, while Alfresco followed the DJIA for the first two years, in the past year, as the DJIA has zigged, we've zagged.

The recession has been very good for open-source Alfresco.

But it's not just us. I've talked with a range of open-source companies that I advise (including SugarCRM, JasperSoft, Volantis, and Openbravo), as well as many that I don't advise (Sun's MySQL, Pentaho, OpenX), and almost universally, every open-source company reports the same thing: economy down, sales up.

This sounds like a perfect storm brewing for impressive VC exits on open-source companies, once valuations catch up with the sales numbers open-source companies are reporting. I would imagine that by late 2009 or early 2010, we'll start to see the economy recover a bit, boosting valuations for mergers and acquisitions. Once that happens, I believe that we'll see VCs start to reap a bountiful harvest on their open-source investments.

Disclosure: I am an employee of Alfresco, an open-source content management and collaboration company.

Follow me on Twitter @mjasay.

While some entrepreneurs seek to protect their ideas with nondisclosure agreements, investor Mark Cuban has a different idea: open-source your business plan.

Mark Cuban

What does this mean? As Cuban explains, it means that start-ups should openly post their business plans online. Yes, this means that a competitor could take a plan and run with it, but given that the quality of execution often differs markedly from the quality of an idea, the risk may be lower than you think.

You must post your business plan here on my blog, where I expect other people can and will comment on it. I also expect that other people will steal the idea and use it elsewhere. That is the idea. Call this an open-source funding environment.

If it's a good idea and worth funding, we want it replicated elsewhere. The idea is not just to help you, but to figure out how to help the economy through hard work and ingenuity. If you come up with the idea and get funding, you have a head start. If you execute better than others, you could possibly make money at it. As you will see from the rules below, these are going to be businesses that are mostly driven by sweat equity.

Actually, most businesses thrive on sweat equity, not intellectual property. Google? There were a range of other search engines available before Google started. Yes, PageRank arguably gave it a technical advantage, but execution (uncluttered search page) made Google what it is. If we were merely concerned by the quality of the search itself, Microsoft and Yahoo would have much better market share than they do.

Open-source venture funding strikes me as a very good idea. It's a chance to smooth some of the rough edges of an idea long before you attempt to put your business plan into practice. Commenting on Cuban's idea, start-up consultant Mark DeWalle notes that "in a network-based culture, it doesn't work to operate with lots of secrecy. Access to information is shifting the competitive paradigm of business from the idea to the execution." He's absolutely right.

Start by open-sourcing your business plan. Then open-source your software too.

Follow me on Twitter at mjasay.

Satish Dharmaraj, founder and former CEO of Zimbra, one of the industry's top open-source start-ups, has joined Redpoint Ventures, a Silicon Valley venture capital firm, as a partner, Dharmaraj confirmed to me by phone on Tuesday.

Dharmaraj sold Zimbra, an open-source e-mail and collaboration company he founded in 2003, to Yahoo for $350 million in 2007. Earlier this year, Dharmaraj left Yahoo to focus on "other things." It's now apparent that the "other things" Dharmaraj had in mind included joining Redpoint, one of the industry's top venture firms.

I asked Dharmaraj about the move and the motivations behind it:

I've started and sold two companies now (Onebox and Zimbra), and was thinking about doing another. I came to the conclusion that a) I love working with entrepreneurs, and b) I can't bear working for a big company.

So I spent the last year doing angel investing, but I didn't like working alone. I've known the Redpoint partners for the past 10 years, and started talking with them last fall about me joining as a partner. Their focus fits really well with mine: cloud computing, software as a service (SaaS), and open source.

Given the shambles that the industry is in, Dharmaraj's timing seems inopportune. But he insists that now is actually an exceptional time to be investing, provided that the focus is right:

Some people think it's a crazy time to invest, but I think it's a great time to invest. Companies born this year will emerge from the recession in 2010/2011 with great momentum and discipline. Even in this bad economic environment, the types of companies I'm interested in dramatically reduce the cost of buying and running software, plus significantly increase productivity through open standards and open source.

For those looking for an experienced investor that seems to have done just about everything right with Zimbra, Dharmaraj should be top of mind. He's a warm but driven executive, someone you'd want to hang out with and report to. And given his track record, he should prove to be an informative adviser to any start-up that is looking to make money while simultaneously enhancing customer freedom.

Follow me on Twitter at mjasay.

Over the past year, the open-source business community has collectively donned a hair shirt over stumbles in venture funding, especially when venture funding in open-source companies took an apparent 12 percent slide in the third quarter of 2008.

However, while the second half of 2008 saw declines in open source-related venture funding, overall, funding levels were 35.5 percent higher than in 2007, according to The 451 Group.

Open Source Venture Funding 2008

(Credit: The 451 Group)

This is pretty amazing, when you consider that overall U.S. venture capital investments plummeted 8 percent over 2007 funding levels, as TechCrunch reports.

U.S. Venture Funding 2008

(Credit: PricewaterhouseCoopers)

And if you treat Washington state as a proxy for Microsoft-related funding (a poor proxy, to be sure, but...), well, TechFlash reports that venture funding there dropped 82 percent from 2007 levels.

True, the prospect of an exit for an open-source company is no better right now than for proprietary software companies, which will likely drag open-source investment declines into parity with their proprietary peers.

Still, for now, open source looks more and more like a safe haven in this battered economy, whether you're spending IT dollars or investing VC dollars.

In a not-so-surprising turn of events, The New York Times reports that Silicon Valley venture capitalists actually care about revenue again.

After years of investing in Web 2.0 companies that generate eyeballs and weird brands but little revenue, VCs have decided that businesses that actually make money are a priority:

For Web sites that do not already have large audiences, "your business model may be just as plausible as it was 18 months ago, but we're all more cautious about giving you a slug of money," [Accel partner Theresia Gouw Ranzetta] said.

Instead, investors are looking for sites that make money in ways other than selling ads, like selling subscriptions or virtual goods. Selling 50 cent costumes for online avatars might not seem to be much of a revenue model, but pennies add up.

This emphasis should actually benefit companies with open-source models, which have seen investments taper off somewhat in the past few quarters.

Given that open source went through its own investment silly season years ago, back when it was fine to have downloads without corresponding dollars, it may make a safer investment for cautious VCs today. A wide array of open-source companies are making solid revenues in the $10 million to $50 million range, either reaching or approaching profitability.

In sum, as VCs focus on value again, just as customers are, open source should benefit.