Open-source software gave birth to a slew of useful software in recent years. Many of the great technologies that we use today were born out of open-source development: Android, Firefox, VLC media player, MongoDB, Linux, Docker and Python, just to name a few, with many of these also developing into very successful for-profit companies.
While there are some dedicated open-source investors such as the Apache Software Foundation incubator and OSS Capital, the majority of open-source companies will raise from traditional venture capital firms.
Our team has raised from traditional venture capital firms like Speedinvest, open-source-specific firms like OSS, and even from more hybrid firms like OpenOcean, which was created by the founders and senior leadership teams at MariaDB and MySQL. These companies understandably have a significant but not exclusive open-source focus.
Our area of innovation is an open-source AutoML server that reduces model training complexity and brings machine learning to the source of the data. Ultimately, we feel democratizing machine learning has the potential to truly transform the modern business world. As such, we successfully raised $5 million in seed funding to help bring our vision to the current marketplace.
Here, we aim to provide insights and advice for open-source startups that hope to follow a similar path for securing funding, and also detail some of the important risks your team needs to consider when crafting a business model to attract investment.
Strategies for acquiring open-source seed funding
Obviously, venture capitalists find many open-source software initiatives to be worthy investments. However, they need to understand any inherent risks involved when successfully commercializing an innovative idea. Finding low-risk investments that lead to lucrative business opportunities remains an important goal for these firms.
In our experience, we found these risks fall into three major categories: market risk, execution risk, and founders’ risk. Explaining all three to potential investors in a concise manner helps dispel their fears. In the end, low-risk, high-reward scenarios obviously attract tangible interest from sources of venture capital.
Ultimately, investment companies want startups to generate enough revenue to reach a valuation exceeding $1 billion. While that number is likely to increase over time, it remains a good starting point for initial funding discussions with investors. Annual revenue of $100 million serves as a good benchmark for achieving that valuation level.
Market risks in open-source initiatives
Market risks for open-source organizations tend to be different when compared to traditional businesses seeking funding. Notably, investors in these traditional startups are taking a larger leap of faith.
Of course, investing in a company poised to disrupt an industry offers a potentially lucrative opportunity. However, investors need to understand that any assumptions about said opportunity are accurate. Additionally, traditional startups already receiving seed funding serve to prove the market-need hypothesis for their product.
If an open-source startup exists in a market with little competition from other “open core” businesses, this provides a significant advantage. Additionally, a traditional business residing in a later stage of their product development lifecycle offers another bonus. They may even already generate revenue, which is also a plus for the open-source startup.
An emerging open-source business seeking funding must use this information when meeting with investors. Why? Simply point to the traditional businesses receiving funding or revenue as a valid assessment of the market risk for their idea. Investors with a better understanding of the market potential are more likely to provide seed funding.
In the case of our startup, traditional companies like DataRobot and Dataiku also produce AI-based tools used in data analytics. These businesses proved that a strong market exists for these tools. We obviously leveraged this fact when meeting with our investors.
Successfully executing the business plan is another critical risk
Proving to investors that an open-source startup possesses the operational skill to successfully achieve its revenue goals is another critical risk for potential investors. Again, differences exist between traditional startups and their open-source equivalents.
One notable difference involves the traditional organization not receiving the opportunity for a long iterative process during product development. Their immediate focus is building something able to generate revenue as quickly as possible. However, a successful proof of concept might not be able to properly scale to meet anticipated demand. Corners get cut and overall quality suffers as a result. Most importantly, revenue projections aren’t met.
On the other hand, open-source projects leverage the broader OSS community, helping to properly vet a product concept. Additionally, this approach allows for developing software more efficiently and with higher velocity. Community members freely offer useful feedback to help fix issues while suggesting useful new features. Multiple development iterations ensure a stable product that’s easily scalable in a high-traffic production environment.
In short, the open-source route simply provides a lower execution risk level than the traditional approach. Once again, the key for an open-core startup is clearly expressing this fact to potential investors.
Investors must trust the founders of an open-source startup
The founders of any open-source startup must work hard to gain the trust of potential investors. It’s the same situation with entrepreneurs leading a traditional startup, especially when considering the risk of the founders actually staying together as a team. However, as with execution risk, open-source companies gain the inherent advantage of building a community around their product.
In fact, boasting a strong community around an emerging open-source product essentially serves as an “introduction letter” to venture capitalists. It highlights the founders’ ability to successfully execute their vision, as well as the mission to bring their product to a commercial reality. Additionally, the iterative nature of open-source projects leads to fostering a sense of teamwork between the founders, their team, and investors and stakeholders.
Ultimately, if you have a great idea, and one that fits within the open-core framework, expect your risks to be much lower than with a traditional business structure. Clearly communicate this fact to venture capitalists for the best chance at securing the seed funding your organization needs.