VCs say open source startups are resilient in a recession

  • Open-source software startups could be resilient in the face of a recession, investors say.
  • The technology remains relevant because it helps companies reduce costs and is used for critical tasks.
  • Companies like Red Hat, HashiCorp, Confluent, and MongoDB have thrived during downturns.

Startup valuations are being trimmed left and right amid a market downturn. But some startups, like those who give away their software, might have the secret while a


recession

say investors.

Some of these startups are resilient because they offer a mission-critical service like cybersecurity technology, Daniel Docter, managing director at venture capital firm Dell Technologies Capital, told Insider. In other cases, companies cut costs during a recession based on where they can save money over the next year, and open-source software is free to use. So customers keep using open source software and startups keep growing.

“If there’s open source software that has a clear path to cost savings in an organization, it’s going to do well,” Docter said.

And there’s a proven track record of open source during a downturn. In fact, founders have built some of the most influential open source companies during recessions and downturns, Joseph Jacks, the founder and general partner of venture capital firm OSS Capital, which invests in open source companies, told Insider.

Red Hat, which IBM bought for $34 billion in 2019, continued to grow during the Great Recession in 2008. That’s partly because it supports Linux, a free alternative to Microsoft Windows, Red Hat chief technology officer Chris Wright previously told Insider.

More recently, the pandemic led to a downturn in 2020. However, open-source software companies GitLab, HashiCorp, and Confluent went public just last year. Meanwhile, MongoDB surged in the markets and Databricks skyrocketed in valuation.

While open-source startups typically sell paid features or support services, the core open-source software is free to view, download, and modify by anyone. That means these startups can acquire customers much more quickly to expand their user bases, Jacks said.

“A lot of the biggest investors I’ve spoken to, people that we invest with, are interested in capital-efficient businesses,” Jacks said. “Open source companies are the most capital efficient.”

Capital efficiency measures a company’s performance compared to the expenditures it spends on producing its products or services. Open source startups meet this standard because they can spend less on sales and marketing but still win customers.

Also, open source software adds another layer of security for companies that use it. If maintainers ever move away from the project, companies can keep the code running because the source code is readily available, Docter said.

Still, it will take years to determine which companies will benefit from, or even emerge from, this downturn. But that’s not stopping investors from announcing funding rounds for commercial open-source software startups each week, Jacks said.

When deciding which open-source startups to invest in, venture capitalists consider the growth potential of the software market, how the open-source community embraces the project, and the founding team, Jacks said. This helps them assess if they are the right people to build a great business and understand market dynamics.

“Do they have to burn $100 million to make $100 million in sales, or do they only have to burn $10 million or $20 million?” Jacks said. “There is a growing consensus that open source falls into the latter category.”

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