A Big Bang for the Buck

Many venture capitalists (VCs) are starting to get excited because they see that OSS can form the basis for a profitable ROI.

As 2005 rings in, the future is sparkling like a diamond for open source software (OSS). The pundits and the investors forecast a strong buy on OSS in all markets — in industry, government, and education segments.

Gartner has predicted that open source software will continue to increase its strong market penetration in Asia. Others, like Forrester, have reported that the use of open source software grew by 30 percent in the last 18 months. Evans, another research organization, noted that there are more than a million developers in North America who spend some of their time working on open source software projects. And according to IDC, businesses and governments in Western Europe will increase their investment in OSS to $228 million by 2008 and the global Linux server market will rise to $9.1 billion in the same period. These trends demonstrate the serious plate tectonics that are shifting the scene in the business of software technology.

Every worthy VC is closely following the money trail of these shifting business plates. Despite a collision of the open source approach with traditional IP models, many VCs are starting to get excited because they see that OSS can form the basis for a profitable return on investment. All analyst numbers point towards growth. And VCs know high growth markets mean big opportunities. Increasingly, the shift from proprietary to open source software is being compared to the melt-down of mainframes by the personal computer revolution.

In the last three years, most financing for OSS projects has come from industry. Players such as IBM allocated $40 million to finance the Eclipse Foundation, Sun Microsystems financed the StarOffice/OpenOffice.org project, SAP contributed to MySQL and the list goes on. Now open source companies are beginning to secure initial rounds of financing from VCs like Draper Fisher Jurvetson, Intel Capital and Matrix Partners. Well-known examples include SugarCRM, SourceLabs, Gluecode, JBoss, Zend, Optaros and Verari — companies that base some or all of their products and services on open source.

A milestone in the growing attractiveness of OSS for the VCs saw the first venture capital company, Voyager Capital, join Portland based OSDL, the non-profit OSS industry consortium and home to Linus Torvalds. Voyager intends to support Linux and OSS business and help create successful entrepreneurs who will use Linux and OSS to build enterprise grade products and services.

As investment money is moving in, the VCs are looking for sustainable business models. Many VCs appear fond of hybrid approaches where OSS and proprietary components harmoniously combine. A textbook example of how open source software can make money is Snort. Martin Roesch wrote Snort, a network intrusion detection and sniffer package and made it open source about 5 years ago. Snort became very popular in the security community so he decided to commercialize his work. Riding on top of and in addition to the open source collaborative engineering model, Snort’s commercial incarnation, Sourcefire, deploys a proprietary package with management and GUI enhancements. This hybrid mix of open source and proprietary software components, has made Sourcefire commercially viable and VC ready. $34 million in VC investment has already helped Sourcefire grow at 50% annually and pushed its valuation to $100 million. Significantly, many of the biggest commercial OSS vendors use this same model. For example, IBM sells middleware using proprietary and OSS components tightly integrated into product and services packages such as Websphere.

“2005 will be a critical year for open source technologies in the entrepreneurial community” said one VC recently. The merger of OSS and venture capital can spell sustainable economic growth for the entire open source software community.