Open-Source App Firms Draw VC Funding

By John Pallatto  |  Posted 2005-10-21

Open-Source App Firms Draw VC Funding

Open-source application software companies have grown to the point where they are starting to catch the attention of venture capital firms looking for new places to put their money.

Previously, open-source operating systems, development tools and database developers had received the lion share of investment from major VC firms.

But this week SugarCRM Inc. announced that New Enterprise Associates, a major Silicon Valley capital firm based in Menlo Park, Calif., has granted it $18.77 million, in what is by far the largest of the three rounds of venture funding the open-source software company has received.

NEA took an interest in SugarCRM because it is demonstrating that it has a successful business model for successfully developing and selling commercial open-source application software, said Scott Sandell, NEA general partner.

"Open source has been a successful way to develop software for some time. But there havent been that many successful business models," particularly in the application software space, Sandell said.

That has been why most of the venture capital investments have gone to companies such as open-source operating system company Red Hat Inc., the MySQL AB database company or to a development tools companies like JBoss Inc., Sandell said.

But SugarCRM has shown that customers will be willing to pay a premium to access the features of its enterprise CRM (customer relationship management) software after they have tried the open-source software on its Web site for free, he said.

"They have developed an outstanding product and they have a world-class management team that has resulting in very rapid adoption of their product," which is apparent from the number of developers who are using the product and posting extensions to it in the community, he said.

Click here to read about why the venture capital community has been slow to support Microsofts .Net development platform.

Open-source application software is particular attractive to China and other developing nations that cant afford to pay the license fees charged on most proprietary applications software developed in the United States, Sandell said.

The company has invested in at least two other open-source companies including Pentaho Corp. of Orlando, Fla., which develops business intelligence applications, and XenSource Inc. of Palo Alto, Calif., which develops virtualization technology,

There is a huge potential market in the developing world for open-source software, he said, because most businesses in that sector have few or no computerized business systems. This could change if they had access to more affordable open-source applications, he said.

Furthermore, the "open-source business model allows local systems integrators and other VARs to modify the product to the local language or to add features that are attractive to the local market" at a much lower cost than is possible with proprietary software, he said.

NEA sponsored an open-source software conference in China this month that attracted "many of the leaders of Chinese open source community," Sandell said. "Chinese software developers are very interested in the open-source approach because it is an affordable way for companies [in China] to gain access to software they need to prosper."

"They see that China can play a role in developing these products, which is typically not the case for proprietary products developed in the United States," he said.

Next Page: The developing world values open source.

The Developing World Values

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Open-source software "is rapidly maturing as part of the overall enterprise applications market and it is becoming more integrated" with an overall market "that used to be just focused on Linux and development tools," said Stuart Williams, an analyst with Technology Business Research Inc. in Hampton, N.H.

"Thats why the VC money is willing to start jumping in," Williams said.

But the quality of the technology is not the only factor that is attracting venture capitalists, Williams said.

"The number one criterion in venture funding decisions is not necessarily the product but the team of people that are bringing that product to the market and their market," he said, echoing Sandells view.

Additional evidence the software industry is taking open-source technology seriously lies in the fact that the biggest technology companies, including IBM, Oracle Corp. and SAP AG, are "investing in and supporting the open-source movements or community as part of defining their entire ecosystem," he said.

Click here to read about how BitTorrent, the peer-to-peer file sharing company, received its first infusion of venture capital money.

IBMs involvement with the Eclipse development tools community and Oracles decision to buy the InnoDB Oy Inc. open-source database engine shows that the big companies understand both the opportunities and challenges that the open-source technology poses to their own business models, Williams said.

It was clear that Oracle acquired the InnoDB technology to have some access and control over a technology that threatens to encroach on its own proprietary database technology, he said.

However, open source "also becomes a gap filler" for large companies looking for ways to augment their own software technology stacks without spending extra money on their own research and development, he said.

SugarCRM itself plans to use the money to fund application and infrastructure enhancements to its Sugar On Demand online CRM service and to expand its product support and services organizations, according to John Roberts, SugarCRM CEO.

To read more about why companies are factoring open source into their business models, click here.

Roberts said the company wasnt actively looking for additional venture capital funding when it was approached by NEA. However, it will "enable us to make more strategic engineering investments and solidify the company in terms of just the financial foundation" for future growth, he said.

What sealed the deal was the experience that Sandell and NEA will bring to SugarCRMs board of directors, Roberts said.

The cash "certainly gives us the runway to make deeper investments in our product road map," Roberts said. "As a young start-up it is nice to have as strong a capital base as some larger corporations," he said.

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