Open Source: The Thinking Man’s Venture Capital?

Open Source: The Thinking Man’s Venture Capital?

Can you make money while giving away a significant part of your company’s intellectual property?

Well, there is Red Hat with its much vaunted billion dollar turnover, and yet many entrepreneurs are still reticent to liberate their own grand plans as an open source product or project.


You could dabble in venture capital funding, by contrast, which involves giving away significant parts of your company. Many see this loss as a fair trade-off since it finances more rapid growth and gives access to a powerful network of contacts and potential customers. But a successful open source ecosystem can deliver many of the same benefits.


Open source and venture backing can both be used to fuel more rapid expansion, and they should certainly not be viewed as mutually exclusive. Open source is no longer the preserve of a handful of intrepid VC fund managers and equity partners.


However, the overlap of many benefits in VC funding and open source development provokes questions.  Do companies using open source development need VC funding? Can open source development be used to supplement external investment? Could open source even be used as a full alternative?


The benefits of a significant capital injection will depend on the company and on the stage of investment. However, nearly all of the most common reasons for seeking VC investment are already covered by building a healthy open source community around your product.


Looking at early stage investment, recipients of external VC funding will typically focus on using the money for speeding the pace of internal product development. By licensing its software liberally and working to build a community, a company built around a popular open source product or project can harness far greater external development resources. Admittedly, with a more open project, the company will have far less control over the direction of these external development resources. However, this simply demands a new skill set: partner and community management becomes a key executive function .


In later stage investment, recipients of VC funding will be more likely to “burn” cash on heavy investments in sales and marketing. Aggressive VCs may even use intensive marketing as a way to get the target addicted to a high burn rate, forcing them into coming back for further investment rounds on far less favorable terms.


An effective open source business model also offers massive benefits for sales and marketing. Strong open source software that answers a genuine business need can very rapidly go viral and distribute itself. It’s common for companies built around open source software to find themselves running to catch up with their software as it goes global.


The more hands-on angel investor might be able to deliver massive value to companies by effecting high-level introductions and opening doors into larger customers, but open source offers a parallel value. “Word-of-message-board” marketing within the developer community can also provide a route into enterprise customers, where bottom-up decision making on IT tools and platforms is becoming an increasingly potent force.


Open source also offers less obvious marketing benefits to the shrewd practitioner. Many companies focused on internal development have to invest heavily into market research and insight from industry analysts. The level of risk involved in conducting the majority of your software design and development behind closed doors is immense. Even with beta testing on friendly customers, the cloth is cut before customers even get to tell you their sizing and what kind of suit they want. You can add a few nips and tucks, but if you make a serious fashion faux pas, the results can be terminal.


With open and community development, customers and partners are involved at the earliest stages of the design and decision making process. Much of the investment in strategic marketing, to provide direction for product development, is rendered unnecessary.


In open source, you can rest assured that if partners and users have problems with the direction you are taking, they will tell you. A company working at the core of an open source community must still provide the lead on vision and direction, as this is the main driver of community building and commercial open source success. However, the level of input and direct contact with the customer removes an enormous element of risk from new product development.


Another major issue for any company looking to expand through external financing is in managing recruitment. Anyone who has ever been involved in growing a business will be all too familiar with how quickly a small, highly productive team can be destroyed and made less productive through bad recruitment choices.


In highly specialized areas of technology and software development, the shortcomings of traditional recruitment companies and processes become painfully obvious. There is the direct cost of recruiting the wrong person for the job in the high-pressure environment of a rapidly expanding company.  The wrong person can also have a “time-sponge” effect on management and colleagues, which can be disastrous.


By contrast, popular open source projects will attract highly skilled developers. External developers who are capable of making it in the harsh meritocracy of an open project must demonstrate their skills, knowledge, and mettle. In addition, many ambitious developers now see contributing to popular or up-and-coming projects as the most effective route into new, exciting, and lucrative positions.


Corporations such as Google, Netflix, Facebook, Sony, Pixar and many others are now releasing a significant amount of open source infrastructure software, purely to act as a magnet to skilled developers they can recruit. Open source can and is being used in the same way by enterprising start-ups.


However, open source is no magic bullet. Just as venture capitalists will only invest in a strong business, you can only build a strong open source community around the most attractive product or project, and competition for developer time is getting ever more fierce.


Despite the polar arguments around open source, it is also far from being a single model for business or development. The 69 software licenses approved by the OSI as “Open Source” differ tremendously, and each has multiple different business models that have been tried around it. Compare Red Hat, Cloudera, Google, and SugarCRM, and the differences between their business models are often greater than their differences with many proprietary software companies.


Even though there is increasing crossover in the form of VC-backed OSS businesses, venture capital and open source development can also be suited to different businesses. The time-investment required to build an open source community may not be suited to an ultra-high-growth business with explosive potential.  Such a business has a significant early-mover advantage and a limited window of opportunity.
OSS is more typically suited to a longer-term business, focused on organic growth. In the short term, OSS can act as a catalyst to rapid international growth. However, the benefits of a community take far longer to realize and are not a quick hit, suited to someone eyeing an early exit-strategy.


Boris Kraft


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