VCs Hope To Leverage Linux Community, Technology

The year 2004 might someday be remembered as the year that venture capitalists got interested in open source — interested enough to fund a number of new companies based on open source, especially Linux.

The year saw a number of funding rounds for such companies as high-end Linux cluster firm Penguin Computing and Linux Networx, and investor interest in open-source companies has been rising so quickly that some analysts say they worry about a possible open-source investment run-up similar to the Internet bubble that virtually defined the turn of the millennium.

“Open source is definitely a hot topic with the venture capital community, there’s no question about that” John Rymer, vice-president of research at Forrester Research, told LinuxInsider.

“It’s where most of the innovation — outside of Microsoft — has moved,” he said.

Standards Emerging

“There is the recognition that Linux has become a very serious business,” agreed Enrico Pesatori, CEO of Penguin Computing, which sells a line of high-performance Linux clusters.

Pesatori said that perhaps the most notable trend in high-end Linux solutions is that they are becoming more standardized, repeatable products. “Every project used to be different from the others, in the early days,” he said. Now, he says, the products are no longer one-offs, but are becoming so productized that even Dell is entering the market.

Open source is becoming more attractive as an investment as venture capitalists come to understand and think of such opportunities as more mainstream, said Itsy Ahmed, a vice president at Oak Investment Partners who was involved in the funding of Linux Networx. Ahmed also told LinuxInsider that part of what makes such ventures attractive is that so much open-source software already has pre-existing communities of active evangelists who can serve as champions — and potential customers — for new products.

Hot Marketing

After satisfying himself that the company meets all of the normal requirements for any promising startup — such as a good business plan and a competent management team — Ahmed looks for someone who has acted as a leader in an open-source community, such as by writing code, serving on standards bodies, and evangelizing for open-source or free-source products. “Having a guru is a good way to distinguish yourself,” Ahmed said.

When it comes to overseas competition against American firms, Ahmed predicts that “for the foreseeable future, open-source business development will continue to be a domestic phenomenon, but contributions to its development will continue to be global.”

That’s because “American entities are a lot more willing to try new solutions, and a lot of informal channels exist in the United States,” said Ahmed. “A spark of development can happen anywhere in the world, but acceptance is a local [American] phenomenon.” That’s something that open-source companies in, say, India, have to work hard to overcome.

The success of open-source software is having broad implications outside of open-source companies’ own corporate boardrooms and lunchrooms. “They’re changing the way the rest of the industry plans to make money off of software,” said Forrester’s Rymer. “There has been a shift from license revenues to making money on support and maintenance, and the open-source movement is really driving that,” he said.

“The dark side is that companies tend to abuse that, raising support and maintenance costs when they get squeezed, and then the customers get whipsawed. We don’t know yet what the implications of this model are yet,” he added.

Dangerous Bandwagon

As a matter of fact, said Rymer, open source might soon suffer from being perceived as too trendy. “What they [VCs] see here is this international movement in development, and it’s an article of faith that it will prove profitable. I worry a little that it has the smell of the Internet boom about it, where people all want to invest in open source, whether they understand it or not,” said Rymer.

Still, Rymer added that “the move toward open source is virtually irreversible … and heating up,” and he predicts that 2005 will see a number of new start-ups based on open source. “I talked to someone recently who was entertaining three different offers to be a CEO of open-source companies,” Rymer said.

Rymer hastened to add that he isn’t against open source; what he finds alarming is a “cowboy attitude” among VCs. “A lot of them just say, ‘This is hotter than hell, so I want my own [open-source] startup,'” said Rymer. “A lot of the companies that are basically just repackaging [free source] are probably going to flame out,” he said.

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