Has Open Source Made Venture Capitalists Irrelevant?

Many entrepreneurs view venture capitalists with a reverence reserved for royalty, so it be surprising to hear that it’s been rough for the royals too. A recent article in The Deal entitled “Honey, I Shrunk the VCs” tells us just that. Return on venture capital funds have fall into single digits, and out of several thousand funds out there, only a few hundred are making active investments. The rest can be expected to disappear as their portfolio companies “unwind.”

The culprits?

Too much money chasing too few good ideas: After stellar returns in the late 1990s, venture capitalist raised unprecedented amounts. Unfortunately, this was not matched by a similar number of good ideas for them to invest in.

Higher hurdle for IPOs: Sarbanes-Oxley and other regulatory changes have made it harder for companies to go public through an IPO, and more portfolio companies now have to be sold to “strategic buyers” such as Sun or Cisco. Returns on sales to strategic buyers are usually lower than those on IPO’s.

Fewer VC’s needed: Most interestingly, the current generation of startups simply need less money. For example, a Web 2.0 startup might need $50,000-$70,000 per month, compared to $1 million a month for a Web 1.0 startup during the late 1990s.

I believe open source has contributed to #3 from this list. Whereas ten years ago, startups bought Sun servers and ran (and paid for) Solaris and Oracle, not to mention commercial software development tools, today’s startups can get up and running with Linux, MySQL, PHP, Java, and Eclipse. Even Solaris is open source and free now. Thanks to open source, it’s easier to start an online business than ever before, so there’s less need to get “funded.”

But open source is still moving forward. Consider opentaps Open Source ERP + CRM. This is an open source suite of business applications, including CRM, accounting, inventory, warehouse and supply chain management, which is freely available. Could these free applications lower the cost of startups in biotechnologies, clean energy, or resource management? I hope so.

More importantly, though, because opentaps is open source, you can study it and modify its source code to suit your needs. This means that it’s not just a set of free applications, but also a toolkit or framework. Could that help create new and innovative applications that we haven’t even dreamt of yet? I hope so.

Now, I don’t think venture capitalists are irrelevant. As long as starting something is hard (and it will probably always be), we’ll need smart people who could help us sift through our ideas and push us forward. But I do hope with open source, making great ideas come true gets a little easier.