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Where top VCs are investing in open source and dev tools (Part 1 of 2)

Arman Tabatabai 4 years

The once-polarizing world of open-source software has recently become one of the hotter destinations for VCs.

As the popularity of open source increases among organizations and developers, startups in the space have reached new heights and monstrous valuations.

Over the past several years, we’ve seen surging open-source companies like Databricks reach unicorn status, as well as VCs who cashed out behind a serious number of exits involving open-source and dev tool companies, deals like IBM’s Red Hat acquisition or Elastic’s late-2018 IPO. Last year, the exit spree continued with transactions like F5 Networks’ acquisition of NGINX and a number of high-profile acquisitions from mainstays like Microsoft and GitHub.

Similarly, venture investment in new startups in the space has continued to swell. More investors are taking shots at finding the next big payout, with annual invested capital in open-source and dev tool startups increasing at a roughly 10% compounded annual growth rate (CAGR) over the last five years, according to data from Crunchbase. Furthermore, attractive returns in the space seem to be adding more fuel to the fire, as open-source and dev tool startups saw more than $2 billion invested in the space in 2019 alone, per Crunchbase data.

Where top VCs are investing in open source and dev tools (Part 2 of 2)

As we close out another strong year for innovation and venture investing in the sector, we asked 18 of the top open-source-focused VCs who work at firms spanning early to growth stages to share what’s exciting them most and where they see opportunities. For purposes of length and clarity, responses have been edited and split (in no particular order) into part one and part two of this survey. In part one of our survey, we hear from:

Vas Natarajan, Accel

Open source is upending major enterprise and IT categories, and it’s no surprise — open-source software is often just better software with a high rate of innovation and maturation. For one, it solves big, complex technical challenges that many proprietary vendors wouldn’t dare touch.

Some of the trickiest scale-out infrastructure and data management problems have been solved by open source — think Kubernetes for container orchestration, or Hadoop for big data management. And with an embedded community, open source matures just as it problem-solves, tackling its own bugs, vulnerabilities and cross-compatibility needs. It improves in all the right ways.

Importantly, customers are tired of proprietary dependencies. Vendor lock-in is a real dilemma for CIOs. Today, being open is a feature, not a bug — CIOs know no matter what, they’re in control. In fact, we rarely hear CIOs picking proprietary products anymore when a better open alternative exists. You can get fired for buying IBM.

But open software doesn’t need to mean “free” software. There’s a big role to play for a commercial company providing support or filling gaps in an open project with proprietary products.

Having a canonical vendor (or a “single throat to choke”) is a great thing as larger customers come online — it’s nice to have someone to call. That legitimizes the project and drives trust for organizations who may be on the fence. We’ve seen big independent businesses built around open source and are due to see many more.

We were learning a lot 15 years ago when we made our first open-source investments in Jboss, XenSource and others. It’s since become a core focus for us. We’ve led seeds/Series As in Sentry, Heptio, Cloudera, Sysdig, Tenable and Corelight, among others.

The key ingredient to them all? A healthy, thriving community of developers and end users who infuse the project with their contributions and importantly, their ambitions. These companies were formed of their community, by their community and for their community. That provenance is so key to focus on early days.

Stephanie Zhan, Sequoia

We’re very excited about the continuous innovation we see in developer tools. It’s a category we’ve long been passionate about — we’re thrilled to have partnered with a number of category-defining developer tool companies in the past, including Stripe, GitHub, MongoDB, Dropbox, Confluent, Docker, among others.

What I love most about the movement is that as purchasing power shifts from traditional CIOs to the developer, the developer is now at the center of decision-making for the adoption of any product, allowing them to make decisions based on quality, ease of use and efficacy. It’s an entirely new distribution model for enterprise products.

We’re excited about lots of opportunities here. In fact, we’ve just partnered with a few seed-stage companies in the broader developer tools category, including Linear, an issues-tracking tool catered to developers; Middesk, a self-serve, API-based suite of products to help build trust infrastructure for businesses at scale; and Evervault, a company building developer tools for data privacy.

I’m looking forward to seeing the category continue to develop and can’t wait for Sequoia to partner with more companies in the space.

Tomasz Tunguz, Redpoint Ventures

Which trends are you most excited about in open source/dev tools from an investing perspective?

We’re spending a lot of time in open source; we’ve invested in four open-source companies in the last year and close to 20 overall. We believe in the rise of open source at the application tier — it is going to continue to drive the way technology is built and platforms that leverage open source will continue to have an edge. We also think open source is a disruptive customer acquisition tool.

In addition, cloud-prem is a novel deployment model for enterprise software — by enabling customers to control their data for cost and compliance, while benefiting from the constant upgrades and improvements of SaaS, enterprises finally don’t need to make trade-offs between the ways their teams want to work and their demands for security and control.

We’re also seeing a huge shift to Kubernetes as the operating system for enterprise workloads. In addition, next-generation databases continue to see significant interest from new buyers, particularly the ones that are cloud-native. Lastly, we’re believers in novel ways of managing cloud applications and ensuring resiliency as the discipline of SRE and operations matures.

How much time are you spending on open source/dev tools right now? Is the market under-heated, overheated or just right?

We’re spending a lot of time here and if anything, our interest is growing. We have invested in companies like HashiCorp, LaunchDarkly, Cockroach, Dremio, Mattermost, DGraph, Solo, Gremlin, StackRox and many others. We’re looking for more.

The space will create many billion-dollar companies because the shift to the cloud is still early. Assume that 20% of the $1.5T in global infrastructure spend has occurred — that’s just the start.

There are two ramifications of this. The first is about $150B of market cap is created every year. Second, if you assume the terminal penetration of cloud is 60%, then the cloud market will be at least 3x what it is today.

Are there startups that you wish you would see in the industry but don’t?

We’re looking for companies to help other companies manage workloads across clouds for managing costs, but also for disaster recovery and resiliency.

Any other thoughts you want to share with TechCrunch readers?

Redpoint has been early into this space with some of our companies really transforming their industries and creating new categories. We’re huge advocates for this change in the industry and we’re behind many of the key companies revolutionizing the way enterprises build and run software.

Deepak Jeevankumar, Dell Technologies Capital

Open source / Dev Tools investments of Dell Technologies Capital: JFrog (unicorn), Min.io, MongoDB (IPO), NS1, Packet (announced to be acquired by Equinix), RedisLabs, Tetrate, Yugabyte

Categories that interest us in open source/dev tools

First, let’s clarify that not all dev tools startups follow the open-source adoption model. Cloud computing has made it easy to use a proprietary/non-open source model to reach developers. Stripe and Twilio are primary examples of dev tools that didn’t follow the open-source adoption model.

Also, many open-source startups are not quite dev tools, but rather enterprise infrastructure tools but follow a bottom-up market adoption model. We broadly look at two major categories here, each of which are very rich and diverse with tens of sub-categories and hundreds of interesting startups.

  1. Enterprise infrastructure: Traditional infrastructure areas that have embraced open source/dev tools innovations include operating systems (e.g. RedHat Linux, CoreOS), DNS infrastructure (e.g. NS1), databases (e.g. MySQL, MongoDB, Yugabyte), data analytics stack (e.g. Hadoop), message bus (e.g. Kafka), storage (e.g. Gluster, Min.io), networking (e.g. Envoy, Istio), payment infrastructure (e.g. Stripe, Plaid) and cybersecurity (e.g. Snort/Sourcefire). In the past, enterprise budgets were mostly controlled by the infrastructure teams (i.e. the CIO office) but not developers. Open-source and dev tools-style products are creating a bottom-up adoption pattern with developers being the beachhead of adoption and the infrastructure teams eventually end up paying for these “tools” for agility, productivity and TCO benefits.
  2. Code Development Process / infrastructure: This category includes all CI/CD tools, code QA testing, code storage & version control (e.g. GitHub, GitLab), artifacts (e.g. JFrog), app deployment infrastructure (e.g. Docker, Kubernetes) and many other sub-categories. The budgets in this category are increasing really fast and the startups can see viral adoption patterns similar to consumer startups.

Value creation and capture in open source/dev tools:

I have a “4M framework:” mindshare, market share (e.g. downloads), money share (revenue), margin share (profits). AWS has all four. It is very essential that open-source/dev tools startups start with creating mindshare (ubiquity in the minds of developers). The valley of death is between marketshare and money share i.e. progressing from value creation to value capture.

There are many popular open-source projects, but very few can monetize even at a small scale. VCs generally invest in open-source projects and make companies out of them after they have achieved critical mass in mindshare in the open-source community.

In many cases, these open-source projects are created in university labs (e.g. Spark/Databricks) or bigger tech companies (e.g. Hadoop/Cloudera, Kafka/Confluent, Open vSwitch/Nicira), where they have had time to mature and capture mindshare before being commercialized.

However, an abundance of VC $ has lowered the bar for this mindshare test. There are also a few startups where VCs invested in founders just as they started to create the open-source projects (e.g. 10gen/MongoDB, Min.io, Docker FKA dotcloud).

Trends that interest us in open source/dev tools

  • Low-code/no-code
  • Mobile app performance testing in the real world before deployment — why should so many apps crash or perform slowly in different network conditions? Can’t this be solved in advance? What is the point of testing them only in the developer’s location?
  • Open-source vulnerability scanning that is integrated into the CI/CD pipeline

Are there startups that you wish to see in the industry but don’t?

  • “Stripe for cybersecurity”: If Stripe can make payments easy for developers, someone should make cybersecurity easy for developers.
  • DevOps-friendly logging: Storing and analyzing logs has become a central piece of IT in the 2010s much like databases in the 1980s. We need a DevOps-friendly approach to rethink this space.

How much time are you spending on open source/dev tools right now? Is the market under-heated, overheated or just right?

About 50%. The market may look over-heated, but we have more disruptions coming!

Anna Khan, CRV

Which trends are you most excited about in open source/dev tools from an investing perspective?

I like to spend my time thinking about what the next paradigm shifts in technology will be. I’ve seen that the best OSS companies were built around some of these large paradigm shifts.

As an example, think of RedHat for Linux, HashiCorp for multi-cloud and Confluent around streaming. The paradigm shifts I’m monitoring right now involve next-gen ETL tools, cloud security and next-gen ETL tools and cloud security.

How much time are you spending on open source/dev tools right now? Is the market under-heated, overheated or just right?

This isn’t a popular viewpoint, but I think the market is still under-heated. The biggest question about the open-source and dev tool space used to be exit opportunities: can these companies exit and accrue value in the public markets? That question has been answered repeatedly by large M&A and IPOs like Twilio, SendGrid and GitHub.

The developer has immense buying power within organizations and focusing on the developer community itself also has strategic value despite strong financial outputs. On the open-source side, we see similar fruition — two record-breaking IPOs for the OS community with Elastic and Pivotal and the largest M&A in history for cloud with RedHat at $33B. Most investors are catching on, but I still think it’s an under-heated market.

Are there startups that you wish you would see in the industry but don’t?

For me, the best dev tools are created around the most critical pain points. It’s hard to build developer tools around new markets until a real “operational problem” exists.

Consequently, I’d love to see more dev tools in the supply chain and manufacturing space and in fintech. Plaid accrued a lot of value in fintech infrastructure because they built a next-gen Yodle, but there is so much more that can be done to connect the system of record-banking data and information to the core customer.

Any other thoughts you want to share with TechCrunch readers?

All my thoughts here! With great quotes from our portfolio leaders.

Peter Levine, a16z

How we look at open source more broadly

Open source started as a way for developers to collaborate and it delivered superior technology to proprietary development efforts, especially at the infrastructure level of the stack (e.g. operating systems, databases). But for decades, the economic value of open source did not match the technological value.

SaaS has unlocked the economic and strategic value of open-source projects and businesses and provided more incentive for developers to invest their time in open-source projects. It’s created an “open-source renaissance.” In the last few years, Cloudera, MongoDB, MuleSoft, Elastic and GitHub were all part of multi-billion-dollar IPOs or M&A deals.

As a result, we see open source proliferating in more types of technologies (e.g. fintech, e-commerce, education, cybersecurity), more parts of the stack, and more places — almost every large proprietary tech company has open source as part of its stack, and the next open-source business is as likely to start inside a large company as in an academic lab (e.g. Preset started within Airbnb; Databricks started at Berkeley).

And this is a good thing for everyone. The surface area of developers engaging with open source is increasing as the incentives increase. With more open source, the best technology spreads faster and the frontier of innovation pushes into new spaces.

Open-source technology we’re excited about

JAMstack as a new way of building websites and web apps is providing developers with tremendous flexibility and speed for innovation. We’re looking forward to seeing a lot more open-source movement there from data stores to front-end frameworks.

Building open-source SaaS (OpenSaaS) businesses

When you are thinking about building the team, having a strong SER team who can respond quickly to downtime/SLA incidents. Operations complexity of standing up a SaaS instance and being to scale it is very different from building engineering teams for non-SaaS open source.

Ilya Kirnos, SignalFire

Which trends are you most excited about in open source/dev tools from an investing perspective?

In a span of not that many years we’ve flipped from enterprises being suspicious of open source to open source being preferred and in many cases mandated from the top. This has coincided with the shift to the cloud, which has both accelerated this move toward open source and enabled new monetization models beyond only selling support.

We believe MuleSoft (whose founder Ross Mason is a venture partner at SignalFire) is only the first of a wave of open-source-based companies to achieve venture-scale success. Every major on-prem software area is up for grabs as workloads move to the cloud, so we’re very active in this space, with recent investments in companies like PlanetScale (scale-out SQL database), SaturnCloud (Python-centric platform for data science) and Anchore (container security), all of which are based on open-source projects.

Developer tools are an interesting one. I’ve spent years as a software engineer and I certainly appreciate how valuable good dev tools are. JetBrains immediately comes to mind, I use their IDEs all the time. On the other hand, engineers hate to pay for software and would often prefer to build vs buy.

What’s changing is that developer productivity is becoming increasingly crucial as more companies become software-driven. We try to find areas where developers would rather outsource the pain and which drive big productivity gains for the organizations employing them.

Examples in our portfolio include OneSignal (push notifications for mobile and web), Crave.io (build infrastructure and acceleration) and Testim.io (ML-driven test automation).

How much time are you spending on open source/dev tools right now? Is the market under-heated, overheated or just right?

We’re spending a lot of time here and have been very active. This area is very broad, so it’s hard to give a single answer on whether it’s overheated, e.g. I think the NoSQL space has been overheated and overhyped and serverless is still very TBD in my view. But there are lots of really promising areas as well.

Are there startups that you wish you would see in the industry but don’t?

I won’t pretend that I know better than founders what should be built…

S. Somasegar, Madrona Venture Group

Which trends are you most excited about in open source/dev tools from an investing perspective? 

Developers, and by extension, developer tools have been in the forefront of open source. Over the years, developer tools have become more and more synonymous with open source so much so that today I think about open source as table stakes for dev tools.

Over the years, open source has transitioned from a “free” only to a “free + support” to a “SaaS” commercial model across the software landscape. In parallel, the enterprise sales and go-to-market motion has also turned on its head in the last decade.

Earlier, the predominant enterprise sales model used to be driven by top-down enterprise sales. Whereas, now the adoption of dev tools and infrastructure products and services in most organizations happen only through grassroots adoption. This has made both open source and a freemium model a critical and core part of the go-to-market strategy of any startup in the dev tools and enterprise infrastructure market.

For open source to truly continue to scale and be successful, companies need to build a two-way relationship and have a good balance of both consuming as well as contributing. Creation of and contribution to open-source projects was initially limited to forward-looking companies.

More of the larger companies have now got onto the open-source bandwagon for a variety of reasons, including better understanding of the give-get that makes the OSS world thrive, ability to attract the very best developers, etc. As a result, the pace of open-source project creation has been rapidly increasing and we expect this trend to continue moving forward.

Cloud computing platform shift is one of the biggest platform shifts we have seen. Cloud is becoming a core part of the development process — not just an afterthought. Again, this trend started with the innovative “born in the cloud” companies, but is becoming more mainstream among all businesses.

Enterprises are getting (if not already) comfortable adopting and buying products and services based on open-source projects particularly as they move to the cloud. The possibilities and opportunities because of this flywheel effect are huge.

How much time are you spending on open source/dev tools right now? Is the market under-heated, overheated or just right?

We strongly believe that open source is an absolutely critical component of the go-to-market strategy of any startup in the dev tools/cloud-native space. As a result, we spend significant time tracking and identifying open-source projects that are gaining traction.

For all the progress that we have seen, it still feels like early days. In some ways overheated (hard to see what’s real versus hype), but in other ways under-heated (those who can figure out business models in conjunction with open source can build multi-billion dollar businesses).

Having said that, the market does feel slightly overheated. There have been a number of open-source projects-based startups that have gotten funding lately without any visibility into what their commercialization path might look like.

Not every open-source project that gets popular on GitHub will have a real business potential. Some of the recent fundings seemed to have discounted that and reflected more of the open source-project’s popularity than the business potential (or lack thereof).

Are there startups that you wish you would see in the industry but don’t?

While ML frameworks such as TensorFlow (~140K stars), Caffe (~30K stars), etc. continue to build on their popularity using such frameworks, [it] is not that easy for enterprises that do not have the right talent and expertise. I wish there were startups building tools to make those frameworks usable by the masses.

As the world moves more and more to cloud computing, there is a huge need for tools to enable developers to observe and understand their software particularly in a world of connected services and distributed systems. That is an area that is ripe for a lot of open-source projects and activity. 

Any other thoughts you want to share with TechCrunch readers?

Every company is a technology company today. Digital transformation is one of the top priorities for every enterprise. This transformation is fundamentally developer-led. This, coupled with the “consumerization of IT” means that developers are more empowered now than ever to build innovative new experiences. Cloud is absolutely a developer’s superpower.

As a startup, it is super important to understand that open source is fantastic. But it is also a one-way door — once a piece of software is open-sourced, it remains that.

Hence, project creators with entrepreneurial aspirations must think long and hard about what they want to open source before they actually do that. They must open source enough so that a developer can do what they couldn’t do otherwise and really see value in adopting that and driving that forward.

Yet, the entrepreneur must also know how they are going to be able to create enough value on top of the open-source project that they can monetize and build a sustainable business around should they decide to start a company.