Flush with Cash
Kevin Harvey, a partner with Benchmark Capital, the Menlo Park, CA VC powerhouse that took an early stake in Red Hat, said his firm is eager to invest in additional open source companies. On top of its Red Hat investment, last summer Benchmark made a $3 million investment in Collab.net, the Internet-based development marketplace for open source.
Kirk Walden, head of venture-capital research for PricewaterhouseCoopers, expects to see more VC activity in the open source arena reported in the fourth quarter.
"I can tell you that VC funds are flush with cash at the moment and have been for at least a year. Deal flow is critical to them. It would not surprise me that Linux companies are getting calls. It's a bit of reverse intuition. You hear of companies going begging for money. Instead, now they get calls from VCs."
Indeed, Benchmark's Kevin Harvey says that the first cold call he'd ever made in his career was to Red Hat. "There appears to be no end in sight for investment in these technology companies," PricewaterhouseCoopers' Walden said. "Everything is in perfect alignment."
Venture-capital firms themselves, however, realize there are risks in throwing money blindly at open source companies, and they are scrutinizing the business plans of their would-be partners meticulously. "We want to make this market happen," said Harvey, noting that Benchmark is not just interested in "me too" open source companies that are trying to imitate the business plans of others. "We want to see new business models and new businesses being built in the open source arena," he said.
Too Many Offers
San Francisco's Linuxcare has been courted by VCs and investors for some time, and on May 1 received an infusion of cash from Kleiner Perkins. Last year, even before the Red Hat IPO, the company had "a couple of companies offer to acquire us," said CEO Fernand Sarrat. "The activity picked up some more after the Red Hat IPO," he added. Despite the current gold-rush environment surrounding open source companies, Sarrat says the specific business plan of each company makes an enormous difference. "There are business plans out there that support strongly the interest to put money into Linux, and there are some business plans that don't. Taking free code and adding stuff to it and publishing and charging for it is a business model that can be easily blown up," he asserts.
"Our goal is to create the infrastructure of support for Linux that would have been there if a company had written Linux. There was no company, so it's our job to put the infrastructure in place," Sarrat said.
At this early stage, investors find it hard to differentiate between lasting models and models that have a higher degree of risk. "Frankly, we have talked to a lot of people, and only one very conservative firm questioned whether Linux was really going to make a space for itself or not. The rest did not question that. The focus was more in our case: What are the business models by which you will make money, are they scalable, and so forth. There is no question that customers are going to buy it," Sarrat said.
"When Linux arrives at a level where it is 31 percent of the Web operating systems, and the Web is pretty large, it clearly bypasses Solaris and NT as the Internet operating system. It's pretty hard to argue there won't be an opportunity there. If you can show you have a decent model, you're going to be in good shape."
Currently, Linuxcare is in the midst of its second round of funding. Though secretive about who the investors are, Sarrat said the company's goal was to raise $25 million, but investors are virtually throwing money at the company. "We already have been offered $300 million," he said. "Our problem is to say no."
Sarrat says Linuxcare will approach a public offering sooner than anticipated because of the enthusiasm for the company's product and business plan.
Of course not all companies are eager to rush into the arms of venture capitalists, especially companies deeply rooted in the open source ethos. A number of open source companies, including Vixie's MIBH and Sendmail, Inc. have secured so-called "angel" investment instead. This kind of investment generally comes in a much more hands-off manner than that of the venture capitalists.
"We went in search of management and money separately," said Vixie. "We'd hoped to find [them both] by talking to top VCs," he said, "In both cases we found what we needed among the community of people who were already involved in our industry."
