After a seven-year run as the top investment-capital segment, software relinquished that position last year to biotechnology investments which checked in with $6.3 billion in funding. In 2003, startup software companies garnered close to $6 billion, or about 25% of all venture-capital dollars, and will likely meet or beat that dollar figure in 2004. Venture capital firms invested about $24 billion last year overall with an increase between 3% and 5% in 2004. Still, that pales in comparison to 2000, when total venture-capital investments surged to a record high of more than $100 billion, more than four times what was invested this past year.

Those years aren’t coming back. But interest in applications that provide security to corporate networks or help manage technology operations still remains high for the investing community. “Back office automation software is not interesting any more, as most of that space has matured and consolidations are occuring even as we speak,” says Ravi Mhatre, general partner at Lightspeed Venture Partners. What the last few years have done, continues Mhatre, is to shift enterprise information into electronic assets. “Any enterprise of a reasonable size, has moved to automated processes in accounting, inventories, cash flow and so on,” he says. Now there is need for a next layer operating above this electronic bank that can act as a monitor that shows intelligent information extraction, performance characteristics, and management of the processes themselves.

Ajit Nazre, an associate partner at Kleiner, Perkins, Caufield and Byers offers a slight contrarian view. As a previous MD of SAPAmericas, Nazre has been in touch with the software market in the real life situations. “I think we have barely scratched the surface of possibilities,” Nazre opines, and concludes that there is much more that software can do to bring increased efficiency in the back-office automation, Internet applications, and supply chain management. “We are in the early days still.”

The latest batch of enterprise-software startups are targeting as potential customers the large companies that are desperate to squeeze more mileage out of existing systems. For example, many companies have implemented multiple network-security-software systems throughout their organization but now need software that can provide a comprehensive view of their entire security infrastructure.

“People don’t always think about it, but the shelf life for most technology is usually only four to five years,” Mhatre says. “Because companies have halted their spending on new technology, most of their infrastructure is either obsolete or soon will be. They need to think about the next generation of technology to get more productivity out of the systems they've already invested in.” Lightspeed invested in Virsa Systems, an enterprise dashboard developer that helps companies comply with the Sarbanes-Oxley mandates.

Another portfolio company that is unique is Skybox Security that develops software to analyze the entire security topology of an organization to locate vulnerabilities—in the firewall, perhaps, or a server used by employees working remotely—and determine action plans. Skybox application then suggests the appropriate remedies needed to secure the network.

In the larger view of the market, says Mhatre, enterprises are now able to do more with less people, as the ROI in their technology investments are showing up. The wider adoption of broadand is influencing the next evolution of software, he observes, as the improved connectivity expands the horizontal connectivity between people themselves, and collaborative software that leverage this connectivity would be an interesting space. The message, he suggests, could be the software.

The Message is the Software
Bill Burnham at Softbank Capital Partners comments extensively on the next generation software prospects with messaging: Back in the 1990’s Sun Microsystems famously coined the term “the network is the computer” in an effort to illustrate that distributed computing, enabled by networks, was destined to triumph over monolithic CPUs. A similar and perhaps more important revolution is now underway in the software world. In this revolution, monolithic compiled binaries are rapidly being replaced by fragments of distributed code held together by increasingly robust message systems. Far from simply relaying information, these message systems are rapidly evolving into “stateful” clouds.” As these vast, intelligent, clouds evolve they are becoming, in many ways, the heart and soul of modern software.

As software fragments and distributes, the role of messaging systems increases in importance for it is these messaging systems that provide the virtual “glue” necessary to hold a distributed application together. Today’s messaging systems are far more complex and capable than their predecessors. Increasingly these systems are not just intermediaries, but an integral and inextricable part of business processes.

One emerging example of an XML-based “stateful” message standard is Business Process Execution Language (BPEL). At one level, BPEL is simply a standard that defines how business partners interact on a particular business process. However, BPEL can also be used as a “stateful” standard in which the business process is both defined and managed by the message itself. The combination of massive numbers of “stateful” messages with a sophisticated infrastructure effectively creates an intelligent messaging “cloud.” Inside this cloud, messages can be routed, modified, and secured with minimal endpoint interactions.

The emergence of this intelligent cloud and the migration towards messaging and away from complied binaries offer a multitude of interesting investment opportunities. Clearly there will be increasing demand for intelligent message processing software and equipment. New companies are likely to emerge focused on brokering messages associated with emerging “stateful” standards and still others may find ways to acceptably secure and control “transgenic” messaging.

As these new companies emerge they will help cement the transition away from binary-centric software towards message-centric software and in doing so they will confirm what we can already see today: that the message is the software.

Change in Go-To-Market Stratgies
Mhatre also proposes that more companies will develop software from user-group feedback, and also get it into market by targetted user download and trial strategies. “Trial versions will become the go-to-market strategy, and the audience will be more keenly involved in the next evolution of the product. Silo-like isolated developments, large licences, and larger sales cycles are fading.” In fact, some software will be licensed on a per-transaction basis, a step further to the per-user license of today. Startups need to shake off the pre-concevied notions of what an enterprise software was till now. Developing features to a larger ERP, CRM, or SCM software, and hawking them as enterprise software will not fetch interest. Today’s customers can be targetted with a high-touch marketing effort, and their demands can be finely defined to evolve a particular platform software. As the General Motor CTO said recently, GM’s cars are moving to increasingly become software-driven transport systems, and vendors would need to create software that can offer customization at the user-level, yet be a partner with GM if the software fails in the warranty.

Venture capitalists concur, though, that the excitement has not gone away from the software markets. “What we need is a fresh perspective,” concludes Mhatre.