Open source is the new normal
While at SquareOne we are not new to open source investments, e.g. VueStoreFront, Codasip + one web3 company still stealth, we have never been public about our investment thesis in the open source space...
…it's time to change this and to present to our community why we want to double down on open source. Also, I am excited to share what (non-obvious) areas of open source I am specifically looking at for future investments.
A quick note: for this post, I am going to focus almost entirely on commercial open source software (COSS) so when I say open source (OS) know that what I really mean is COSS.
Why open source — An answer from the 💘
I always thought that open source was cool from the very first time someone told me about it. People from all over the globe, who probably never met each other, come together and build software on an openly shared code basis accessible for free for everyone. The closest thing to a “collective brain” that I can think of, such a powerful concept.
And what amazing technologies have been built on this premise! Web browsers (Mozilla Firefox, Brave), operating systems (Linux), programming languages and frameworks (Python, React, VueJS) and cryptocurrencies (Bitcoin, Ethereum).
And developers love it! Data suggest that more and more developers contribute to open source projects every year. In 2021 rough 3M developers contributed for the first time to an open source project compared to 0.8M in 2016.
Why open source — An answer from the 🧠
Besides the empirical observation that many great companies (think Elastic, Hashicorp, Gitlab, Confluent etc. etc.) are in fact open source and are growing faster than comparable closed source peers, I can think of 6 structural advantages of open source companies versus traditional closed source companies:
1. True USP vs big techs [building or demolishing🏰]
In 2022, cloud software is a mature industry that has given rise to some of the largest companies in the history of mankind, the so-called “big techs”. Next to them stands a long line of other 100bn+B2B Software giants the likes of Workday, Salesforce, Adobe, Shopify etc. I would argue that if any of these companies really wanted to enter the market where a new startup is in, they would win or at least cause critical damage. Unless…this new startup could offer something that no big tech can offer…a core product with transparent, accessible source code that can be downloaded and self-hosted if really needed…in other words open source!
Or looking at it from the other side: if you are a founder starting a company in 2022 and want to enter a market where a 100bn+ company is dominating and keeps growing, open source can be your best shot at it. Using the words of someone smarter than me:
You’re trying to commoditize your competitors, and then sell something else to your installed base.
2. Looking under the hood before buying [sales cycle ⏲]
From the buyer's perspective, the ability to look at how a product is actually built under the hood can build confidence, also from an IT security standpoint. This is especially true if the vendor is not a well-known and established company. I would even argue that for verticals where open source is king (big data, dev ops, infrastructure, web3 tooling) a 100% closed-source product would nowadays almost raise eyebrows. A 180° change compared to the last decade when open source was seen as the exception.
To look under the hood and test a product is even more important when a developer is the main buying decision-maker and I believe that this is also why many of the biggest open-source success stories have been developer tools companies.
3. Get early validation from many users [community validation 💡]
One of the hardest things when building is to find product-market fit. To find product-market fit a company needs feedback from many users. But how can a company get many users to start with? Open source is a fantastic way to solve this chicken-and-egg problem, as users will often be more prone to test an open-source product and be more forgiving of bugs (they are getting some version of the product for free forever). With a bit of luck, your testers might even help you fix bugs or build with you. Of course, the core team of maintainers, especially at the beginning, is expected to do the heavy lifting.
4.Co-develop with the community [community building💪]
On top of gathering early feedback from the community when starting a new project, the power of an active community can manifest itself later on in multiple shapes and forms; one of the most interesting ones, is co-developoing part of the product with active contributors of the community. For example, a group of contributors could develop the code for a niche use case that is useful for them initially while that use case would have been not big enough to justify internal development efforts of the core team. Contributors can be individuals but also corporations and usually the bigger and the more successful a project is, the more corporate contributors will be involved. The biggest and most famous example of what I mentioned before is Linux where hundreds of corporations contribute substantially to the code base.
5. Qualified sales leads [community distribution model 🚚]
Open source as a ”distribution model” is a phrase you often hear these days, some would even say that open source is in essence a distribution model (I disagree!). In short, users that come for the free product and the community are also a pool of qualified leads for commercial products/services that can be sold on top of the open source product.
Arguably it is not easy to know who is doing what with an open source product, therefore community tools like Discord and Discourse can help to pinpoint users.
6. Qualified HR leads [hiring model 👨💻]
Hiring is a pain for almost all tech companies and this is especially true for engineering roles. On top of that, bad hires are very costly and can hinder the growth trajectory of early-stage tech companies. Lastly, ramp-up time for new hires is also a factor to consider when budgeting.
I argue that open source companies have, also in HR, structural advantages versus traditional companies. In fact, open source companies are able to easily identify engineering candidates based on contributions in their repository. Additionally, companies have a lot of data points about how a contributor works, thus diminishing the chances of a bad hire. Lastly, new hires are by default already familiar with the source code as they have already been working on it.
Of course, it must be noted that open source companies won't be able to satisfy 100% of their technical HR needs by hiring contributors.
Drawbacks and vulnerabilities of open source companies 🛑
In contrast to all the above-mentioned advantages, open source companies are also facing a series of challenges that traditional closed source companies do not have:
1. Monetization 🤹♂️
What monetization model to go for? What to keep free for the community and what to monetize upon? Arguably this is *the challenge* for the vast majority of open source companies out there.
I will not attempt to propose my view on this largely debated topic but rather I have put together a curated list of articles that provide an overview of monetization models for OS and weigh the pro and cons for each model
-> -> To the Open Source Monetization Resources <- <-
Whatever you choose just keep 2 things in mind:
- Once you choose a model it is not easy to come back and change it
- See the next chapter of the article :)
2. Avoid an AWS-Elastic moment 😓
Every open source founder should be (and probably is) aware of the AWS-Elastic story. If you are not, find below a link, the tl;dr is that AWS was selling products based on top of Elastic under the name of AWS. Much thought should go into selecting the proper license based on the stage and product. Former Paua portco founder, Lars Kamp, wrote a great post about how he selected one open source license for his company. In the post, he also speaks about AWS-Elastic and the dilemma of how to choose the right license.
Areas of interest for new investments
I argue that the most “organic verticals“ for open source are already saturated, such as DBs, ML and infrastructure. I expect 4 other areas to see major open source traction in the immediate future and I will especially look into those for investments:
1. Alternatives to existing closed source tools
“If only there was an open source version of….”
I do believe there are exciting opportunities in offering an open source alternative to some existing products. As mentioned above, open source products offer some structural advantages like a free basic offering, being able to look under the hood and test, having a community providing bottom-up feedback to the product. Why not have some of the best tools out there but with these features? Wouldn't you like a free car that you would pay only if you turn the IC on or if you drive faster than 80 km/h?
Clearly, I am not the only one betting on this space as Rajko of NEA wrote a whole post about it and Runa Capital published on Github an extensive list of open source alternatives called “awesome oss alternatives”
2. Open-source enablers
“can I trust/use this open source project?”
As more and more companies decide to build their product with an open source approach, it intuitively makes sense that a series of “enabler” products start to emerge to support this wave of new companies. These enablers are for example companies that make it easier to build an open source company/product, to maintain a community of contributors and to securely adopt open source tools for corporations. In particular, I am bullish about topics such as security and open source community tooling. A fantastic example is a company like Fossa
3. Financial services/banking infrastructure
“From software to “bank the unbanked” to software to run the top banks”
Core banking and financial services software have traditionally been “open source” resistant as a consequence of higher security standards and a lack of tooling that facilitate open source adoption in heavily regulated industries. Large OS projects like Apache Fineract have being focussed on microfinance or banking the unbanked. I argue that a new wave of open source products in the banking/ financial services sectors will emerge thanks to more tooling to facilitate open source adoption, more decisional power shifting to the hands of developers and increased pressure on banks to modernize their infrastructure.
Angela of A16Z has a similar opinion and wrote a whole blog post about this.
4. Web3 tooling
“why are web3 founders using closed sourced products to build their product/communities?”
Web3 can be considered a subcategory of open source or not, but one thing is undisputed: web2 open source products are on the technical side and concerning their ethos much closer to web3 when compared to traditional closed sourced companies.
As web3 applications and in particular DAOs (Decentralized Autonomous Organizations, basically communities sharing a token-based cap table) are set to take the main stage after layer1s and NFTs, I believe that a set of enabling tools will pop up to support web3 entrepreneurs and my bet is that a good all of them will be open source and a portion of them will have a token-based model.
That’s it, folks! If you are a founder in the open source/ web3 tooling space and this investment thesis resonates with what you are building I would love to hear from you -> federico@squareone.vc
Or if you are a fellow investor also focused on these topics I would also love to chat.
Last but absolutely not least THANK YOU Lars, Sam, Georg, Felix, Niels, Charlotte, Sasha, Misha for critically reviewing my post and helping to make it much better.
