Do Open Source and Venture Capital Mix?

The short answer is in fact a question: “Why not?” Or more pertinently, we should be asking why we are asking this question at all. For starters, it is not quite fair to group all venture capitalists together, nor does it really make sense doing the same for open source projects. Open source business models after all range from support and services, to largely commercial models where proprietary code is monetized on top of open source assets, and there is a lot of middle ground.

I list below some common arguments against venture capital mixing with open source and the counter-arguments to each of them. You as the reader can make up your own mind.

As for myself, I remain very neutral to the issue – meaning that I believe that at the present moment there is only a minority of venture capital firms that can work effectively with open source companies, and I hope this will change in the future in a way that benefits both open source and venture capital. Now that I’ve stated my position, the arguments…

Argument 1

Venture capital is obsessed with the possibility of exit, which may not be good for open source after all, especially if the exit is a sale to a proprietary software company (like what happened to MySQL inadvertently through Sun?). And frankly, it’s not necessarily good for innovation (which I believe is the real goal of venture capital, not profits :) ).  See Fork Well: It Could Be The Last, Best Hope for Community for a “free software centric” but very understandable reaction early on in the Oracle-Sun merger news cycle.

Counter-argument 1

There are many possible good investment exits for open source companies that are good for open source in general, such as a merger with or an acquisition by a larger and more influential open source player (e.g. Red Hat), or an IPO. If companies like Novell who are increasing their open source portfolio become more oriented to open source and successful at the same time, it can also be beneficial. And in the Oracle case, there are others that have argued that they have supported many other open source projects after acquisition, such as JBoss and BerkeleyDB (but admittedly it is difficult to analyze what would have been if these stayed independent or were acquired by other organizations instead).

Argument 2

The whole venture capital industry is based on valuations through traditional corporate measures, which is ill-equipped to value open source communities. In fact, it can be argued that the open source communities transcend corporate boundaries and therefore company-based investment simply is somewhat antithetical to the structure. It’s like fitting a square peg into a round hole.

Counter-argument 2

The venture capital industry is in a state of turmoil (CNET News: Big changes needed in the venture capital market), and coping with the nature of open source is part of the transformation that it needs to have in order to reinvent itself. Part of that is finding new models for valuation, adjusting to different investment timeframes, and part of that might involve some drastic changes (which are coming).

Argument 3

The perceived legal risk around commercializing on top of open source licensed technology scares many venture capitalists.

Counter-argument 3

Venture capitalists and their lawyers are gradually understanding that not all open source licenses are the same, and that the legal text together with an understanding of the community reflects a clear enough line (and therefore measurable risk) that is drawn between what should be “community property” and what falls within the prerogative of the companies operating in the community. With more information, entrepreneurs that are cognizant of these constraints (which are in fact strengths if the business plan is sound) should be able to convince potential investors that risks are mitigated.

Argument 4

Venture capital investment could crowd out and discourage community involvement. There could be many reasons for this but in general it might have the potential of disrupting the well-functioning status quo within an existing community which may reduce the contribution of other members who feel that they benefit less from the investment that the company directly being invested in. There may also be a perception of conflict of interest affecting the judgement of community leaders who are founders, employees or significant shareholders of the company receiving venture capital.

Counter-argument 4

Founders, employees or significant shareholders of the company receiving venture capital can “walk-the-talk” and give back generously to the community. In fact, they must, if their business is to be successful. Venture capital has been shown in many cases to have resulted in successful open source companies that are good for open source. After all, venture capital was invested in Red Hat, Zimbra, Xensource, and many others.

On the other hand, many venture capital companies have traditionally prided themselves of being actively involved in adding value (not just financing) to the companies that they invest in. How many venture capital companies invested in open source companies can say the same in terms of their role in helping the community? But I suspect that this again is more of a “lack of understanding” problem and not necessarily the fundamental conflict of interest that many perceive. Things might be better as more and more successful open source entrepreneurs/investors gain experience. Some organizations that clearly benefit a lot from open source clearly have more role to play, say (possibly controversial), e.g. Google Ventures?

For more information:

  1. Remarks by Matt Asay, one of the influential people in open source today in an interview about how open source and commercialization mix: http://www.infoworld.com/d/developer-world/open-source-roundtable-matt-asay-176?r=54
  2. Open-source VC investments: Time for payback (post on The Open Road blog at CNET) http://news.cnet.com/8301-13505_3-10217824-16.html
  3. Report of venture capital investment in open source related firms from 1997 to 2008: http://blogs.the451group.com/opensource/2009/04/08/the-past-present-and-future-of-vc-investment-in-open-source/

And as a postword, perhaps one day open source may not need venture capital as we know it today, but then maybe venture capital may not be what it is today tomorrow anyway, at least for open source.

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1 Comment

Filed under Disruption, Economics, Open Source, Venture Capital

One response to “Do Open Source and Venture Capital Mix?

  1. Nelson

    Joichi Ito has some interesting comments on this topic: http://www.youtube.com/watch?v=-Ox02qM_yuc

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