Venture Dollars Flow to Open Source

Open-source software, once seen as the province of propeller heads and anticapitalist visionaries, is winning the respect of the most clear-eyed capitalists of all: the venture capital community.

In the last few years, venture funding for open-source companies has jumped from $72 million in 2002 to $262 million in 2005, according to Venture One. Meanwhile, the number of open-software start-ups funded in those years climbed from 11 in 2002 to 30 in 2005.

Open-source companies have received just a small fraction of the total VC money going into technology. Indeed, "conventional" software start-ups garnered $5.5 billion in venture funding last year, 20 times more than their unconventional siblings. But investors with long experience in the tech wars of Silicon Valley say the momentum behind open-source software is stronger than it appears.

"Waves start long before you see them on the surface," says Ann Winblad, co-founder of Hummer Winblad, a San Francisco-based venture fund. "We've long since learned that open source is not about free software."

Red Hat(RHT Quote), which supports a popular version of the Linux operating system, is perhaps the best known open-source provider, with revenue that has grown from about $80 million in 2002 to $278 million in its fiscal year 2006.

Profit has grown as well, from a loss of 83 cents a share to a gain of 41 cents a share this year. But unlike Red Hat, the new wave of open-source start-ups are applications companies.

Azure Capital, for example, has invested more than $18 million in open-source start-ups since 2002. Its portfolio illustrates the breadth of open-source applications companies, including Zend, which makes development tools and languages; Medsphere, a developer of medical information software; and Fonality, which sells open-source-based PBX systems.