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Open Source Software Is Big Business With Big Funding

Although it’s tempting to think that a technology sector predicated on open development and distribution of software would be a lousy place to do business, open source software (OSS) is a surprisingly lucrative industry that has heated up in the last decade.

Regarding the business side, more often than not, open source software companies offer their underlying software for free but charge hefty premiums for custom configurations and implementation consulting services.

Recently, Microsoft announced that it inked an agreement to acquire Deis from platform-as-a-service (PaaS) provider Engine Yard. The team behind Deis, maker of popular container management tools for managing software deployed on Kubernetes, will join Microsoft to help build out container management capabilities on Azure, its cloud computing platform.

It’s important to note that Deis was not originally developed by Engine Yard. The company came into possession of Deis when it acquired OpDemand, its progenitor, in April 2015. Although the Deis team will leave Engine Yard to work with Microsoft, Engine Yard CEO Beau Vrolyk confirmed in a tweet that “Engine Yard is still doing fine,” that he is and will remain the CEO of Engine Yard, and that he and his staff will “continue to grow the company.”

How does Microsoft’s acquisition of Deis fit into the broader landscape of the open source software business? Let’s examine the question through the lens of fundraising by open source software companies and the exit options that follow.

Open Source Startup Funding

We’ll start with analyzing the pace of fundraising activity by open source software companies in both the number of rounds raised and dollars invested. The two are tightly correlated but not in lock-step with one another.

Over the past decade, there has been a notable increase in the number of open source software companies raising capital. The general trendline can be found in the chart below, which is based on an analysis of 545 US Dollar-denominated global deals in the OSS space struck between 2007 and the end of Q1 2017.

Fundraising activity in open source software companies was on a steady nine-year bull run through 2015. But investment into open source software companies, along with those in other sectors, slowed down significantly in 2016. However, 2017 is shaping up to be another solid year for the open source software sector based on the Crunchbase Q1 2017 VC report.

Open Source Software Startup Funding In 2017 To Date

If investment activity in the first quarter of 2017 is any indication of how the open source software sector will fare in the remaining three, it’s likely that the 2016 contraction in funding activity for OSS has reversed course. It’s even possible funding could meet or exceed 2015 levels by the end of 2017.

Thus far, in 2017, Crunchbase data reveals that over $371 million has been invested in just 13 US dollar-denominated deals for which funding amounts are included. Most of this is attributable to Magento, makers of a widely-used ecommerce platform, which raised $250 million in a private equity round from Beijing-based Hillhouse Capital Group. Also on the later-stage side of funding, Confluent, makers of a real-time data platform built atop Apache Kafka, raised a $50 million Series C round from Sequoia and Index Ventures.

In the realm of early-stage startups, SnapRoute, which builds software that enables network engineers to customize off-the-shelf networking switches and routers, raised a $25 million Series A round led by Norwest Venture Partners with participation from AT&T, Microsoft Ventures, and Lightspeed Venture Partners. In January, Blockstack raised a $4 million Series A round to further their efforts to build a decentralized Internet on a blockchain. That deal was led by Union Square Ventures and included the likes of AngelList founder Naval Ravikant and Barry Silbert from the Digital Currency Group.

At seed stage, FOSSA announced a $2.2 million round, and it plans to continue work on an open source software-license compliance monitoring service. That deal was led by Bain Capital Ventures and included Salesforce founder Marc Benioff. Also in February, Keymetrics, which is developing a monitoring tool for Node.js servers, raised $2 million.

At this point, just a few short weeks into the second quarter of 2017, it’s still too early to declare how 2017 will shape up for OSS firms. But if the first quarter’s pace keeps up, 2017 will go down as a banner year for open source software companies.

Acquisitions In Open Source, From Two Sides

Mergers and acquisitions activity in the open source software space has ebbed and flowed over the past decade or so. However, there is a general, if loose, upward trend in the annual count of acquisitions. This applies to both the acquisition habits of companies in the open source category and those outside the category making acquisitions of open source software companies.

Below is a chart depicting M&A activity in the open source software space over the last decade. The light blue line shows acquisition activity of open source software companies, and the darker blue line shows acquisitions made by open source software companies.

Apart from the recent Deis deal, there have been several other acquisitions in the open source software space worth noting.

February 27, 2017, was an interesting day for open source software acquisitions. On that day, Mozilla announced that it had made its first strategic acquisition of Read It Later, makers of the popular link saving and bookmarking browser extension Pocket. Even though Pocket was closed-source, the extension and related projects developed by Read It Later will be open-sourced under the aegis of Mozilla. Also on that day, blockchain company Bloq acquired blockchain analytics company Skry for an undisclosed sum.

Licensing: Open Source Software’s (Potential) Achilles Heel

In January, NoSQL database company RethinkDB’s copyright, assets, and open source codebase was acquired by the Cloud Native Computing Foundation for $25,000. Its code will live on under the Apache License, Version 2.0.

The ultimate demise of RethinkDB, which raised a total of $23.2 million since being founded in 2009, is a case study in the tricky nature of open source software licensing. Most reports attribute the company’s failure to its use of the GNU Affero General Public License, Version 3. The license requires that code which interacts with a modified version of the open source software in question must also be open sourced, which makes it difficult for companies with complicated proprietary codebases to use code licensed under Affero GPL—unless said corporations are comfortable with open-sourcing proprietary code.

For its part, RethinkDB downplayed the role of licensing issues in its failure. But the general sentiment is that the company’s choice of license adversely affected its position in the market. As such, it may not be fair to point to the failure of RethinkDB as a failure of the open source business model per se. RethinkDB could just be another run-of-the-mill startup failure, not a direct result of being an open source software company.

For OSS, There Is An Open Future

Microsoft’s acquisition of Deis was just the most recent public indicator of ongoing interest in the open source software market from both sides. On the M&A side, there are plenty of open source software companies that continue to acquire startups, both open- and closed-source, and integrate their teams and tech into the core business.

And on the investment side of things, venture capitalists continue to back open source software companies. Over the past couple of decades, many companies have emerged to bridge the gap between the ideals of the open source software community and the need to generate revenue to support the continued development of open platforms, standards, and programs.

So much of the technology we all use—that entrepreneurs and engineers start and build, and that investors continue to buy into—rests on top of open source software. The benefits provided by open source software almost always outweigh the hassles of complying with licenses. It’s tricky business, sure, but it’s also literally the foundation of the Internet, operating systems, and, increasingly, the hardware that runs that infrastructure.

Open source software may often be free to use, but it’s not being discounted.