IT WAS A BIG FIRE DRILL FOR ME,” SAYS KEVIN Harvey, a partner with Benchmark Capital. “I cleared my calendar a lot of times, making sure that the company talked to enough references about us to understand what we bring to the table. The deal was competitive and happened in less than two weeks.”

The case in point is My SQL, a developer of open source database, in which Benchmark Capital recently invested $19.5 million. There were many firms that were interested in investing in the company. But Harvey made sure that he met the company’s proposed terms and beat out five other investors.

Harvey is smitten by open source. Benchmark took an early stake in Red Hat. On top of its Red Hat investment, Benchmark has invested in CollabNet, a provider of collaborative software development services based on open source principles. “We want to see new business models and new businesses being built in the open source arena,” says Harvey.

Yet another venture-capital firm that has been the most active in open source investments is August Capital, which has funded open source firms Cygnus, TurboLinux, and Cobalt Networks. Vivek Mehra, partner at August Capital has been keenly watching this space ever since he co-founded Cobalt Networks in 1996 and built server appliances on open source technologies. He raised over $45m in financing before taking it public in 1999. Cobalt was acquired by Sun for $2 billion in December 2000.

Mehra says, “VCs are ready to pump in money into open source startups having unique business models and building meaningfully different products.”

Investing In Open-Source
The early skecpticism in investing in open source startups was wiped out with the Red Hat IPO in 1999. It convinced investors that a new market was emerging. The IPO generated excitement within the VC community toward helping the Open Source community to turn great code into sustainable businesses. However, investors soon found it hard to differentiate between lasting models and models that have a higher degree of risk. Mehra recommends investors to separate the technology from the business model, while they make their analysis.

Harvey doesn’t believe that the investment momentum has really caught up. “No doubt, VCs are attracted towards the growth that they see in open source. But they are afraid of the new business models. I don’t think there is any great investment in open source, yet,” he notes.

Focus Areas
Mehra points out that VCs are excited in companies that develop infrastructure software based on open source modules. “These are horizontal applications and have broad customer bases,” he notes. Most open source products are being developed in the areas of storage, security, databases (MySQL) and application servers (JBOS, NetWare).These are areas where open source technologies are most appropriate.

Mehra advocates a horizontal approach by Open Source companies. “Open Source companies will not be very successful if they develop vertical niche applications.”

Harvey believes in generating revenue by large volumes. “The trick to be successful in this space is to have millions of customers and charge less for the support and upgrades.” He is skeptical about product companies because they may not be able to generate necessary volumes. “I don't think there is a good business model for every piece of open-source application that is out there.”

Mehra, however, subscribes to companies that have a product approach. “There are number of open source companies that have service models or a customer support model. No doubt this model generates revenue and is profitable. But it is hard to scale because to generate additional revenue you have to generate more customers. This is one reason why there are only a few large companies based on open source model,” he says. “Product companies are able to scale faster.”

The Drivers
The stability of the open-source platform combined with the low cost of Intel hardware is driving growth according to Harvey. On the software front he observes that readily available open source features, large community support and lower price has spurred the enterprises to embrace open-source.

Many enterprises are moving towards open source because they think it is cheaper. Also open source ensures that enterprises need not be tied to a particular vendor. “One of the biggest dangers I see is that open source companies pricing their product too high. Sometimes open source products are priced higher than similar proprietary software. Such a trend is beginning in the operating systems segment and will not be welcome by the market,” Mehra reckons.

Both Harvey and Mehra are united on one count. Like Harvey, Mehra too points out that there are ample business opportunities in open source space. “It is certainly a great time for more startup companies. The market is only going to improve from hereon. The next couple of years is the best time to build an open source company,” says Mehra.