There exist millions of Open Source projects today, but many of them aren't sustainable. Scaling Open Source projects in a sustainable manner is difficult. A prime example is OpenSSL, which plays a critical role in securing the internet. Despite its importance, the entire OpenSSL development team is relatively small, consisting of 11 people, 10 of whom are volunteers. In 2014, security researchers discovered an important security bug that exposed millions of websites. Like OpenSSL, most Open Source projects fail to scale their resources. Notable exceptions are the Linux kernel, Debian, Apache, Drupal, and WordPress, which have foundations, multiple corporate sponsors and many contributors that help these projects scale.
We (Dries Buytaert is the founder and project lead of Drupal and co-founder and Chief Technology Officer of Acquia and Matthew Tift is a Senior Developer at Lullabot and Drupal 8 configuration system co-maintainer) believe that the Drupal community has a shared responsibility to build Drupal and that those who get more from Drupal should consider giving more. We examined commit data to help understand who develops Drupal, how much of that work is sponsored, and where that sponsorship comes from. We will illustrate that the Drupal community is far ahead in understanding how to sustain and scale the project. We will show that the Drupal project is a healthy project with a diverse community of contributors. Nevertheless, in Drupal's spirit of always striving to do better, we will also highlight areas where our community can and should do better.
Who is working on Drupal?
In the spring of 2015, after proposing ideas about giving credit and discussing various approaches at length, Drupal.org added the ability for people to attribute their work to an organization or customer in the Drupal.org issue queues. Maintainers of Drupal themes and modules can award issues credits to people who help resolve issues with code, comments, design, and more.
Drupal.org's credit system captures all the issue activity on Drupal.org. This is primarily code contributions, but also includes some (but not all) of the work on design, translations, documentation, etc. It is important to note that contributing in the issues on Drupal.org is not the only way to contribute. There are other activities—for instance, sponsoring events, promoting Drupal, providing help and mentoring—important to the long-term health of the Drupal project. These activities are not currently captured by the credit system. Additionally, we acknowledge that parts of Drupal are developed on GitHub and that credits might get lost when those contributions are moved to Drupal.org. For the purposes of this post, however, we looked only at the issue contributions captured by the credit system on Drupal.org.
What we learned is that in the 12-month period from July 1, 2015 to June 30, 2016 there were 32,711 issue credits—both to Drupal core as well as all the contributed themes and modules—attributed to 5,196 different individual contributors and 659 different organizations.
Despite the large number of individual contributors, a relatively small number do the majority of the work. Approximately 51% of the contributors involved got just one credit. The top 30 contributors (or top 0.5% contributors) account for over 21% of the total credits, indicating that these individuals put an incredible amount of time and effort in developing Drupal and its contributed modules:
How much of the work is sponsored?
As mentioned above, from July 1, 2015 to June 30, 2016, 659 organizations contributed code to Drupal.org. Drupal is used by more than one million websites. The vast majority of the organizations behind these Drupal websites never participate in the development of Drupal; they use the software as it is and do not feel the need to help drive its development.
Technically, Drupal started out as a 100% volunteer-driven project. But nowadays, the data suggests that the majority of the code on Drupal.org is sponsored by organizations in Drupal's ecosystem. For example, of the 32,711 commit credits we studied, 69% of the credited work is "sponsored".
We then looked at the distribution of how many of the credits are given to volunteers versus given to individuals doing "sponsored work" (i.e. contributing as part of their paid job):
Looking at the top 100 contributors, for example, 23% of their credits are the result of contributing as volunteers and 56% of their credits are attributed to a corporate sponsor. The remainder, roughly 21% of the credits, are not attributed. Attribution is optional so this means it could either be volunteer-driven, sponsored, or both.
As can be seen on the graph, the ratio of volunteer versus sponsored don't meaningfully change as we look beyond the top 100—the only thing that changes is that more credits that are not attributed. This might be explained by the fact that occasional contributors might not be aware of or understand the credit system, or could not be bothered with setting up organizational profiles for their employer or customers.
As shown in jamadar's screenshot above, a credit can be marked as volunteer and sponsored at the same time. This could be the case when someone does the minimum required work to satisfy the customer's need, but uses his or her spare time to add extra functionality. We can also look at the amount of code credits that are exclusively volunteer credits. Of the 7,874 credits that marked volunteer, 43% of them (3,376 credits) only had the volunteer box checked and 57% of them (4,498) were also partially sponsored. These 3,376 credits are one of our best metrics to measure volunteer-only contributions. This suggests that only 10% of the 32,711 commit credits we examined were contributed exclusively by volunteers. This number is a stark contrast to the 12,888 credits that were "purely sponsored", and that account for 39% of the total credits. In other words, there were roughly four times as many "purely sponsored" credits as there were "purely volunteer" credits.
When we looked at the 5,196 users, rather than credits, we found somewhat different results. A similar percentage of all users had exclusively volunteer credits: 14% (741 users). But the percentage of users with exclusively sponsored credits is only 50% higher: 21% (1077 users). Thus, when we look at the data this way, we find that users who only do sponsored work tend to contribute quite a bit more than users who only do volunteer work.
None of these methodologies are perfect, but they all point to a conclusion that most of the work on Drupal is sponsored. At the same time, the data shows that volunteer contribution remains very important to Drupal. We believe there is a healthy ratio between sponsored and volunteer contributions.
Who is sponsoring the work?
Because we established that most of the work on Drupal is sponsored, we know it is important to track and study what organizations contribute to Drupal. Despite 659 different organizations contributing to Drupal, approximately 50% of them got 4 credits or less. The top 30 organizations (roughly top 5%) account for about 29% of the total credits, which suggests that the top 30 companies play a crucial role in the health of the Drupal project. The graph below shows the top 30 organizations and the number of credits they received between July 1, 2015 and June 30, 2016:
While not immediately obvious from the graph above, different types of companies are active in Drupal's ecosystem and we propose the following categorization below to discuss our ecosystem.
|Traditional Drupal businesses||Small-to-medium-sized professional services companies that make money primarily using Drupal. They typically employ less than 100 employees, and because they specialize in Drupal, many of these professional services companies contribute frequently and are a huge part of our community. Examples are Lullabot (shown on graph) or Chapter Three (shown on graph).|
|Digital marketing agencies||Larger full-service agencies that have marketing led practices using a variety of tools, typically including Drupal, Adobe Experience Manager, Sitecore, WordPress, etc. They are typically larger, with the larger agencies employing thousands of people. Examples are Sapient (shown on graph) or AKQA.|
|System integrators||Larger companies that specialize in bringing together different technologies into one solution. Example system agencies are Accenture, TATA Consultancy Services, Capgemini or CI&T.|
|Technology and infrastructure companies||Examples are Acquia (shown on graph), Lingotek (shown on graph), BlackMesh, RackSpace, Pantheon or Platform.sh.|
|End-users||Examples are Pfizer (shown on graph), Examiner.com (shown on graph) or NBC Universal.|
Most of the top 30 sponsors are traditional Drupal companies. Sapient (120 credits) is the only digital marketing agency showing up in the top 30. No system integrator shows up in the top 30. The first system integrator is CI&T, which ranked 31st with 102 credits. As far as system integrators are concerned CI&T is a smaller player with between 1,000 and 5,000 employees. Other system integrators with credits are Capgemini (43 credits), Globant (26 credits), and TATA Consultancy Services (7 credits). We didn't see any code contributions from Accenture, Wipro or IBM Global Services. We expect these will come as most of them are building out Drupal practices. For example, we know that IBM Global Services already has over 100 people doing Drupal work.
When we look beyond the top 30 sponsors, we see that roughly 82% of the code contribution on Drupal.org comes from the traditional Drupal businesses. About 13% of the contributions comes from infrastructure and software companies, though that category is mostly dominated by one company, Acquia. This means that the technology and infrastructure companies, digital marketing agencies, system integrators and end-users are not meaningfully contributing code to Drupal.org today. In an ideal world, the pie chart above would be sliced in equal sized parts.
How can we explain that unbalance? We believe the two biggest reasons are: (1) Drupal's strategic importance and (2) the level of maturity with Drupal and Open Source. Various of the traditional Drupal agencies have been involved with Drupal for 10 years and almost entirely depend on on Drupal. Given both their expertise and dependence on Drupal, they are most likely to look after Drupal's development and well-being. These organizations are typically recognized as Drupal experts and sought out by organizations that want to build a Drupal website. Contrast this with most of the digital marketing agencies and system integrators who have the size to work with a diversified portfolio of content management platforms, and are just getting started with Drupal and Open Source. They deliver digital marketing solutions and aren't necessarily sought out for their Drupal expertise. As their Drupal practices grow in size and importance, this could change, and when it does, we expect them to contribute more. Right now many of the digital marketing agencies and system integrators have little or no experience with Open Source so it is important that we motivate them to contribute and then teach them how to contribute.
There are two main business reasons for organizations to contribute: (1) it improves their ability to sell and win deals and (2) it improves their ability to hire. Companies that contribute to Drupal tend to promote their contributions in RFPs and sales pitches to win more deals. Contributing to Drupal also results in being recognized as a great place to work for Drupal experts.
We also should note that many organizations in the Drupal community contribute for reasons that would not seem to be explicitly economically motivated. More than 100 credits were sponsored by colleges or universities, such as the University of Waterloo (45 credits). More than 50 credits came from community groups, such as the Drupal Bangalore Community and the Drupal Ukraine Community. Other nonprofits and government organization that appeared in our data include the Drupal Association (166), National Virtual Library of India (25 credits), Center for Research Libraries (20), and Welsh Government (9 credits).
Infrastructure and software companies
Infrastructure and software companies play a different role in our community. These companies are less reliant on professional services (building Drupal websites) and primarily make money from selling subscription based products.
Acquia, Pantheon and Platform.sh are venture-backed Platform-as-a-Service companies born out of the Drupal community. Rackspace and AWS are public companies hosting thousands of Drupal sites each. Lingotek offers cloud-based translation management software for Drupal.
The graph above suggests that Pantheon and Platform.sh have barely contributed code on Drupal.org during the past year. (Platform.sh only became an independent company 6 months ago after they split off from CommerceGuys.) The chart also does not reflect sponsored code contributions on GitHub (such as drush), Drupal event sponsorship, and the wide variety of value that these companies add to Drupal and other Open Source communities.
Consequently, these data show that the Drupal community needs to do a better job of enticing infrastructure and software companies to contribute code to Drupal.org. The Drupal community has a long tradition of encouraging organizations to share code on Drupal.org rather than keep it behind firewalls. While the spirit of the Drupal project cannot be reduced to any single ideology-- not every organization can or will share their code -- we would like to see organizations continue to prioritize collaboration over individual ownership. Our aim is not to criticize those who do not contribute, but rather to help foster an environment worthy of contribution.
We saw two end-users in the top 30 corporate sponsors: Pfizer (158 credits) and Examiner.com (132 credits). Other notable end-users that are actively giving back are Workday (52 credits), NBC Universal (40 credits), the University of Waterloo (45 credits) and CARD.com (33 credits). The end users that tend to contribute to Drupal use Drupal for a key part of their business and often have an internal team of Drupal developers.
Given that there are hundreds of thousands of Drupal end-users, we would like to see more end-users in the top 30 sponsors. We recognize that a lot of digital agencies don't want, or are not legally allowed, to attribute their customers. We hope that will change as Open Source continues to get more and more adopted.
Given the vast amount of Drupal users, we believe encouraging end-users to contribute could be a big opportunity. Being credited on Drupal.org gives them visibility in the Drupal community and recognizes them as a great place for Open Source developers to work.
The uneasy alliance with corporate contributions
As mentioned above, when community-driven Open Source projects grow, there becomes a bigger need for organizations to help drive its development. It almost always creates an uneasy alliance between volunteers and corporations.
This theory played out in the Linux community well before it played out in the Drupal community. The Linux project is 25 years old now has seen a steady increase in the number of corporate contributors for roughly 20 years. While Linux companies like Red Hat and SUSE rank highly on the contribution list, so do non-Linux-centric companies such as Samsung, Intel, Oracle and Google. The major theme in this story is that all of these corporate contributors were using Linux as an integral part of their business.
The 659 organizations that contribute to Drupal (which includes corporations), is roughly three times the number of organizations that sponsor development of the Linux kernel, "one of the largest cooperative software projects ever attempted". In fairness, Linux has a different ecosystem than Drupal. The Linux business ecosystem has various large organizations (Red Hat, Google, Intel, IBM and SUSE) for whom Linux is very strategic. As a result, many of them employ dozens of full-time Linux contributors and invest millions of dollars in Linux each year.
In the Drupal community, Acquia has had people dedicated full-time to Drupal starting nine years ago when it hired Gábor Hojtsy to contribute to Drupal core full-time. Today, Acquia has about 10 developers contributing to Drupal full-time. They work on core, contributed modules, security, user experience, performance, best practices, and more. Their work has benefited untold numbers of people around the world, most of whom are not Acquia customers.
In response to Acquia’s high level of participation in the Drupal project, as well as to the number of Acquia employees that hold leadership positions, some members of the Drupal community have suggested that Acquia wields its influence and power to control the future of Drupal for its own commercial benefit. But neither of us believe that Acquia should contribute less. Instead, we would like to see more companies provide more leadership to Drupal and meaningfully contribute on Drupal.org.
Who is sponsoring the top 30 contributors?
|1||dawehner||560||84.1%||77.7%||9.5%||Drupal Association (182), Chapter Three (179), Tag1 Consulting (160), Cando (6), Acquia (4), Comm-press (1)|
|3||alexpott||409||0.2%||97.8%||2.2%||Chapter Three (400)|
|4||Berdir||383||0.0%||95.3%||4.7%||MD Systems (365), Acquia (9)|
|5||Wim Leers||382||31.7%||98.2%||1.8%||Acquia (375)|
|6||jhodgdon||381||5.2%||3.4%||91.3%||Drupal Association (13), Poplar ProductivityWare (13)|
|7||joelpittet||294||23.8%||1.4%||76.2%||Drupal Association (4)|
|8||heykarthikwithu||293||99.3%||100.0%||0.0%||Valuebound (293), Drupal Bangalore Community (3)|
|9||mglaman||292||9.6%||96.9%||0.7%||Commerce Guys (257), Bluehorn Digital (14), Gaggle.net, Inc. (12), LivePerson, Inc (11), Bluespark (5), DPCI (3), Thinkbean, LLC (3), Digital Bridge Solutions (2), Matsmart (1)|
|10||drunken monkey||248||75.4%||55.6%||2.0%||Acquia (72), StudentFirst (44), epiqo (12), Vizala (9), Sunlime IT Services GmbH (1)|
|11||Sam152||237||75.9%||89.5%||10.1%||PreviousNext (210), Code Drop (2)|
|12||borisson_||207||62.8%||36.2%||15.9%||Acquia (67), Intracto digital agency (8)|
|13||benjy||206||0.0%||98.1%||1.9%||PreviousNext (168), Code Drop (34)|
|14||edurenye||184||0.0%||100.0%||0.0%||MD Systems (184)|
|15||catch||180||3.3%||44.4%||54.4%||Third and Grove (44), Tag1 Consulting (36), Drupal Association (4)|
|16||slashrsm||179||12.8%||96.6%||2.8%||Examiner.com (89), MD Systems (84), Acquia (18), Studio Matris (1)|
|18||mbovan||174||7.5%||100.0%||0.0%||MD Systems (118), ACTO Team (43), Google Summer of Code (13)|
|20||rakesh.gectcr||163||100.0%||100.0%||0.0%||Valuebound (138), National Virtual Library of India (NVLI) (25)|
|23||mikeryan||150||0.0%||89.3%||10.7%||Acquia (112), Virtuoso Performance (22), Drupalize.Me (4), North Studio (4)|
|24||jhedstrom||149||0.0%||83.2%||16.8%||Phase2 (124), Workday, Inc. (36), Memorial Sloan Kettering Cancer Center (4)|
|27||stefan.r||146||0.7%||0.7%||98.6%||Drupal Association (1)|
|28||bojanz||145||2.1%||83.4%||15.2%||Commerce Guys (121), Bluespark (2)|
|29||penyaskito||141||6.4%||95.0%||3.5%||Lingotek (129), Cocomore AG (5)|
|30||larowlan||135||34.1%||63.0%||16.3%||PreviousNext (85), Department of Justice & Regulation, Victoria (14), amaysim Australia Ltd. (1), University of Adelaide (1)|
We observe that the top 30 contributors are sponsored by 45 organizations. This kind of diversity is aligned with our desire not to see Drupal controlled by a single organization. The top 30 contributors and the 45 organizations are from many different parts in the world and work with customers large or small. We could still benefit from more diversity, though. The top 30 lacks digital marketing agencies, large system integrators and end-users -- all of whom could contribute meaningfully to making Drupal for them and others.
Evolving the credit system
The credit system gives us quantifiable data about where our community's contributions come from, but that data is not perfect. Here are a few suggested improvements:
- We need to find ways to recognize non-code contributions as well as code contributions outside of Drupal.org (i.e. on GitHub). Lots of people and organizations spend hundreds of hours putting together local events, writing documentation, translating Drupal, mentoring new contributors, and more—and none of that gets captured by the credit system.
- We'd benefit by finding a way to account for the complexity and quality of contributions; one person might have worked several weeks for just one credit, while another person might have gotten a credit for 30 minutes of work. We could, for example, consider the issue credit data in conjunction with Git commit data regarding insertions, deletions, and files changed.
- We could try to leverage the credit system to encourage more companies, especially those that do not contribute today, to participate in large-scale initiatives. Dries presented some ideas two years ago in his DrupalCon Amsterdam keynote and Matthew has suggested other ideas, but we are open to more suggestions on how we might bring more contributors into the fold using the credit system.
- We could segment out organization profiles between end users and different kinds of service providers. Doing so would make it easier to see who the top contributors are in each segment and perhaps foster more healthy competition among peers. In turn, the community could learn about the peculiar motivations within each segment.
Like Drupal the software, the credit system on Drupal.org is a tool that can evolve, but that ultimately will only be useful when the community uses it, understands its shortcomings, and suggests constructive improvements. In highlighting the organizations that sponsor work on Drupal.org, we hope to provoke responses that help evolve the credit system into something that incentivizes business to sponsor more work and that allows more people the opportunity to participate in our community, learn from others, teach newcomers, and make positive contributions. We view Drupal as a productive force for change and we wish to use the credit system to highlight (at least some of) the work of our diverse community of volunteers, companies, nonprofits, governments, schools, universities, individuals, and other groups.
Our data shows that Drupal is a vibrant and diverse community, with thousands of contributors, that is constantly evolving and improving the software. While here we have examined issue credits mostly through the lens of sponsorship, in future analyses we plan to consider the same issue credits in conjunction with other publicly-disclosed Drupal user data, such as gender identification, geography, seasonal participation, mentorship, and event attendance.
Our analysis of the Drupal.org credit data concludes that most of the contributions to Drupal are sponsored. At the same time, the data shows that volunteer contribution remains very important to Drupal.
As a community, we need to understand that a healthy Open Source ecosystem is a diverse ecosystem that includes more than traditional Drupal agencies. The traditional Drupal agencies and Acquia contribute the most but we don't see a lot of contribution from the larger digital marketing agencies, system integrators, technology companies, or end-users of Drupal—we believe that might come as these organizations build out their Drupal practices and Drupal becomes more strategic for them.
To grow and sustain Drupal, we should support those that contribute to Drupal, and find ways to get those that are not contributing involved in our community. We invite you to help us figure out how we can continue to strengthen our ecosystem.
We hope to repeat this work in 1 or 2 years' time so we can track our evolution. Special thanks to Tim Lehnen (Drupal Association) for providing us the credit system data and supporting us during our research.
Last week I made a comment on Twitter that I'd like to see Pantheon contribute more to Drupal core. I wrote that in response to the announcement that Pantheon has raised a $30 million Series C. Pantheon has now raised $50 to $60 million dollars of working capital (depending on Industry Ventures' $8.5M) and is in a special class of companies. This is an amazing milestone. Though it wasn't meant that way, Pantheon and Acquia compete for business and my Tweet could be read as a cheap attack on a competitor, and so it resulted in a fair amount of criticism. Admittedly, Pantheon was neither the best nor the only example to single out. There are many companies that don't contribute to Drupal at all – and Pantheon does contribute to Drupal in a variety of ways such as sponsoring events and supporting the development of contributed modules. In hindsight, I recognize that my tweet was not one of my best, and for that I apologize.
Having said that, I'd like to reiterate something I've said before, in my remarks at DrupalCon Amsterdam and many times on this blog: I would like to see more companies contribute more to Drupal core – with the emphasis on "core". Drupal is now relied upon by many, and needs a strong base of commercial contributors. We have to build Drupal together. We need a bigger and more diverse base of organizations taking on both leadership and contribution.
Contribution to Drupal core is the most important type of contribution in terms of the impact it can make. It touches every aspect of Drupal and all users who depend on it. Long-term and full-time contribution to core is not within everyone's reach. It typically requires larger investment due to a variety of things: the complexity of the problems we are solving, our need for stringent security and the importance of having a rigorous review-process. So much is riding on Drupal for all of us today. While every module, theme, event and display of goodwill in our community is essential, contributions to core are quite possibly the hardest and most thankless, but also the most rewarding of all when it comes to Drupal's overall progress and success.
I believe we should have different expectations for different organizations based on their maturity, their funding, their profitability, how strategic Drupal is for them, etc. For example, sponsoring code sprints is an important form of contribution for small or mid-sized organizations. But for any organization that makes millions of dollars with Drupal, I would hope for more.
The real question that we have to answer is this: at what point should an organization meaningfully contribute to Drupal core? Some may say "never", and that is their Open Source right. But as Drupal's project lead it is also my right and responsibility to encourage those who benefit from Drupal to give back. It should not be taboo for our community to question organizations that don't pull their weight, or choose not to contribute at all.
For me, committing my workdays and nights to Drupal isn't the exhausting part of my job. It's dealing with criticism that comes from false or incomplete information, or tackling differences in ideals and beliefs. I've learned not to sweat the small stuff, but it's on important topics like giving back that my emotions and communication skills get tested. I will not apologize for encouraging organizations to contribute to Drupal core. It's a really important topic and one that I'm very passionate about. I feel good knowing that I'm pushing these conversations from inside the arena rather than from the sidelines, and for the benefit of the Drupal project at large.
I sent an internal note to all of Acquia's 700+ employees today and decided to cross-post it to my blog because it contains a valuable lesson for any startup. One of my personal challenges — both as an Open Source evangelist/leader and entrepreneur — has been to learn to be comfortable with not being understood. Lots of people didn't believe in Open Source in Drupal's early days (and some still don't). Many people didn't believe Acquia could succeed (and some still don't). Something is radically different in software today, and the world is finally understanding and validating that some big shifts are happening. In many cases, an idea takes years to gain general acceptance. Such is the story of Drupal and Acquia. Along the way it can be difficult to deal with the naysayers and rejections. If you ever have an idea that is not understood, I want you to think of my story.
This week, Acquia got a nice mention on Techcrunch in an article written by Jake Flomenberg, a partner at Accel Partners. For those of you who don't know Accel Partners, they are one of the most prominent venture capital investors and were early investors in companies like Facebook, Dropbox, Slack, Etsy, Atlassian, Lynda.com, Kayak and more.
The article, called "The next wave in software is open adoption software", talks about how the enterprise IT stack is being redrawn atop powerful Open Source projects like MongoDB, Hadoop, Drupal and more. Included in the article is a graph that shows Acquia's place in the latest wave of change to transform the technology landscape, a place showing our opportunity is bigger than anything before as the software industry migrated from mainframes to client-server, then SaaS/PaaS and now - to what Flomenberg dubs, the age of Open Adoption Software.
It's a great article, but it isn't new to any of us per se – we have been promoting this vision since our start nine years ago and we have seen over and over again how Open Source is becoming the dominant model for how enterprises build and deliver IT. We have also shown that we are building a successful technology company using Open Source.
Why then do I feel compelled to share this article, you ask? The article marks a small but important milestone for Acquia.
We started Acquia to build a new kind of company with a new kind of business model, a new innovation model, all optimized for a new world. A world where businesses are moving most applications into the cloud, where a lot of software is becoming Open Source, where IT infrastructure is becoming a metered utility, and where data-driven services make or break business results.
We've been steadily executing on this vision; it is why we invest in Open Source (e.g. Drupal), cloud infrastructure (e.g. Acquia Cloud and Site Factory), and data-centric business tools (e.g. Acquia Lift).
In my 15+ years as an Open Source evangelist, I've argued with thousands of people who didn't believe in Open Source. In my 8+ years as an entrepreneur, I've talked to thousands of business people and dozens of investors who didn't understand or believe in Acquia's vision. Throughout the years, Tom and I have presented Acquia's vision to many investors – some have bought in and some, like Accel, have not (for various reasons). I see more and more major corporations and venture capital firms coming around to Open Source business models every day. This trend is promising for new Open Source companies; I'm proud that Acquia has been a part of clearing their path to being understood.
When former skeptics become believers, you know you are finally being understood. The Techcrunch article is a small but important milestone because it signifies that Acquia is finally starting to be understood more widely. As flattering as the Techcrunch article is, true validation doesn't come in the form of an article written by a prominent venture capitalist; it comes day-in and day-out by our continued focus and passion to grow Drupal and Acquia bit by bit, one successful customer at a time.
Building a new kind of company like we are doing with Acquia is the harder, less-traveled path, but we always believed it would be the best path for our customers, our communities, and ultimately, our world. Success starts with building a great team that not only understands what we do, but truly believes in what we do and remains undeterred in its execution. Together, we can build this new kind of company.
Founder and Project Lead, Drupal
Co-founder and Chief Technology Officer, Acquia
In my latest SXSW talk, I showed a graphic of each of the major technology giants to demonstrate how much of our user data each company owned.
I said they won't stop until they know everything about us. Microsoft just bought LinkedIn, so here is what happened:
By acquiring the world's largest professional social network, Microsoft gets immediate access to data from more than 433 million LinkedIn members. Microsoft fills out the "social graph" and "interests" circles. There is speculation over what Microsoft will do with LinkedIn over time, but here is what I think is most likely:
- With LinkedIn, Microsoft could build out its Microsoft Dynamics CRM business to reinvent the sales and marketing process, helping the company compete more directly with SalesForce.
- LinkedIn could allow Microsoft to implement a "Log in with LinkedIn" system similar to Facebook Connect. Microsoft could turn LinkedIn profiles into a cross-platform business identity to better compete with Google and Facebook.
- LinkedIn could allow Microsoft to build out Cortana, a workplace-tailored digital assistant. One scenario Microsoft referenced was walking into a meeting and getting a snapshot of each attendee based on his or her LinkedIn profile. This capability will allow Microsoft to better compete against virtual assistants like Google Now, Apple Siri and Amazon Echo.
- LinkedIn could be integrated in applications like Outlook, Skype, Office, and even Windows itself. Buying LinkedIn helps Microsoft limit how Facebook and Google are starting to get into business applications.
Data is eating the world
In the past I wrote that data, not software, is eating the world. The real value in technology comes less and less from software and more and more from data. As most businesses are moving applications into the cloud, a lot of software is becoming free, IT infrastructure is becoming a metered utility, and data is what is really makes or breaks business results. Here is one excerpt from my post: "As value shifts from software to the ability to leverage data, companies will have to rethink their businesses. In the next decade, data-driven, personalized experiences will continue to accelerate, and development efforts will shift towards using contextual data.". This statement is certainly true in Microsoft / LinkedIn's case.
If this deal shows us anything, it's about the value of user data. Microsoft paid more than $60 per registered LinkedIn user. The $26.2 billion price tag values LinkedIn at about 91 times earnings, and about 7 percent of Microsoft's market cap. This is a very bold acquisition. You could argue that this is too hefty a price tag for LinkedIn, but this deal is symbolic of Microsoft rethinking its business strategy to be more data and context-centric. Microsoft sees that the future for them is about data and I don't disagree with that. While I believe acquiring LinkedIn is a right strategic move for Microsoft, I'm torn over whether or not Microsoft overpaid for LinkedIn. Maybe we'll look back on this acquisition five years from now and find that it wasn't so crazy, after all.
As founders of startups raise money from investors, their share of the company gets "diluted". This means the percentage of the company they own gets smaller and smaller. Last month a friend asked me the following question: "What do you believe would be a good equity position as a startup founder after a Series A? I don't want to be diluted too much.". This week, another friend who is in the process of raising money asked me if he should accept certain "preferences" from his potential investors in favor of a higher valuation and less dilution.
My answer to both friends was: "Well, euh, it's complex!". Because I get asked about this regularly, I decided to write a blog post about this. In this blog post, I'll discuss the dilutive effect of (1) of multiple rounds of funding, (2) reverse vesting, (3) options pools, (4) pro-rata rights and (5) liquidation preferences.
Raising Series A
Let's assume that we have a company, and that our company raised four rounds of financing the past five years:
|Series A||Series B||Series C||Series D|
"Pre-money valuation" refers to a company's valuation before it receives outside financing, while "post-money valuation" refers to the company's value after the capital injection. So, the post-money valuation is the sum of the pre-money valuation plus the capital raised. The pre-money valuation of your company, along with the amount of capital raised will determine the founders' dilution.
If our company raises its first round of funding (Series A) with a pre-money valuation of $4 million and the Series A investors were to commit $1.3M, the company would have a post-money valuation of $5.3 million. In the example, the Series A investors would receive 25% of the company ($1.3 million is 25% of $5.3 million).
|Series A investors||25%|
In an earlier blog post, I recommended a specific formula for deciding how much to give up to an investor in each round. For consistency, this post follows that formula. I consider this formula to be an ideal scenario, and recognize that most founders will be in a situation where they have to give up much more, or even be in a situation where they want to give up more. Don't get hung up on the actual numbers used in our example.
You would think that in our example, the founders would be left with 75% of the company after raising their Series A. Unfortunately, this is not usually the case; investors will often insist that an "option pool" is created. An option pool is an amount of the startup's common stock reserved for future employees. Investors expect the employee option pool will equal 10%-20% of the company post-investment; they also expect these shares will be set aside from the founders' equity.
Let's say that the Series A investors' term sheets requires a "15% fully diluted post money option pool" to be setup. This means that the investors want 15% of the company, after the financing is closed, to be in an option pool that will be granted to future employees. The "capitalization table" of our company after the Series A would look like this:
|Series A investors||25%|
|Employee option pool||15%|
The bottom line is that instead of owning 75% of the company, the founders will end up owning 60% of the company, and the investors 25%. For the founders, the $1.3 million financing was not 25% dilutive but 40% dilutive.
As an entrepreneur, I think it is flawed to take the option pool out of the founders' equity; the option pool should be carved out after the financing and dilute both the founders and the investors. After all, future employees who are granted options after the financing add value to the post-money valuation of the company. I'll leave that gripe for another blog post but for the purpose of this blog post, the key take-away is that creating an option pool is usually dilutive for the founders and an important part of the negotiation with investors. The option pool size and the pre-money valuation need to be looked at together and can both be negotiated. Investors should price on the basis of a complete team needed to execute on the opportunity. If the founders have done a good job of hiring that team, the pool size should be smaller. If there are still a lot of hires needed to create a full team to execute, then the pool needs to be larger.
Stock options provide employees the right to purchase a set amount of shares for a set price in the future. To encourage employees to stick around, they don't gain control over their options for a period of time. This period is known as the "vesting period". Once the options are vested, they can be exercised. When you exercise the stock options, you buy shares in the company, usually at a very low price.
Founders are different from employees because they received their shares when they started the company -- they don't usually have stock options. To make sure that founders stay with the company, investors will set up a "reverse vesting" strategy. This is similar to "stock option vesting" except that it gives investors the right to repurchase shares already owned by the founders. The "vesting period" in this context measures how many shares the company can repurchase from a departing founder. The longer a founder stays with the company, the less stock the company can repurchase if a founder were to leave.
A founder who remains with the startup through the end of a particular vesting period -- typically four years -- will be fully vested and retain all founder's shares. The founder who leaves before the vesting period expires will most likely be diluted as the company repurchases some founder's shares.
Raising Series B
As our company grows and the time comes to raise a Series B, the expectation is that the valuation of our company has increased. Let's assume we used that $1.3 million well, and that the value of the company grew from $5.3 million to $13 million.
If we raise $3,250,000 additional capital in a Series B financing on a pre-money valuation of $13 million, then the series B investors will get 20% of the company. In the Series B, the founders, the employees (option pool), and Series A investors are all diluted. Often the new investors will require that the option pool is increased. Let's say they want the option pool to remain at 15% -- in this case, the founders, employees and Series A investors would suffer additional dilution on top of the 20%. In our example, the total dilution will be a little over 23%. The new capitalization table looks as follows:
|Series A||Series B|
|Series A investors||25%||19%|
|Series B investors||20%|
|Employee option pool||15%||15%|
It's not always as simple though. Investors will usually insist on "pro-rata rights". Pro-rata rights give investors the right to invest in a startup's future rounds and maintain their ownership percentage as the company grows and raises more capital. It is an important tool for early stage investors, as most of their investments fail. Pro-rata rights allow investors to "follow" the investments that are doing well. Their ability to double-down on winners is important to compensate for their losses. I believe it is fair to give early investors pro-rata rights; they are a reward for backing you early. But as I've learned, this is also where things get complicated.
At times, new investors don't want older investors to participate so that they can take more of the round. Usually, the new investors will insist that they put enough money to work so they can own a substantial-enough share of the company to make the investment worth their time and effort. In this case, the new investors will try to force the old investors to give up their pro-rata rights. Other times, the new investors want early investors to demonstrate their confidence in the company by participating in the round, and to show that they are not overpaying. To facilitate the "pro-rata dance" between investors, and to satisfy both the old and new investors, founders are often required to take more dilution and to give up more of their company. For simplicity, I ignored pro-rata rights in our running example, but founders need to be aware of how pro-rata rights can impact dilution in later funding rounds.
Raising Series C and Series D
Our company continues to grow and goes on to raise Series C and Series D:
|Series A||Series B||Series C||Series D|
|Series A investors||25%||19%||15%||14%|
|Series B investors||20%||16%||15%|
|Series C investors||15%||13%|
|Series D investors||10%|
|Employee option pool||15%||15%||15%||15%|
In our example, the founders would end up with 34% of the company after four rounds of financing (assuming no additional option grants for the founders). As mentioned above, I consider that an exceptional outcome for the founders. Most founders will own substantially less at this point. For example, Aaron Levie, founder of Box, owned about 4% of Box when the company made its public offering in 2015. Zendesk founder and CEO Mikkel Svane owned about 8% at its IPO in 2014, and ExactTarget's co-founder owned 3.8% at the time the company filed its S-1.
But there is more -- I warned you it's complex! When investors put money in your company, they will require the company issue them "preferred stock". Investors' preferred stock has various "preferences" over "common stock", owned by founders and employees. One of the most common preferences are "liquidation preferences". A liquidation preference helps investors make sure that they'll be paid before common shareholders when a company is sold, declares bankruptcy, or goes public. This is especially important when the company is being liquidated for less than the amount invested in it.
If our company was to sell for $75 million, you would think that per the table above, the Series D investor would make $7.5 million (10% of $75 million) and the founders would make $25.5 million (34% of $75 million). However, if our Series D investor negotiated a "liquidation preference" equal to their $10 million investment and the company is sold for $75 million, they will be guaranteed their $10 million back. The remaining $65 million would go to the other shareholders. This is called a "1x liquidation, non-participating preference". In the event the company sells for less than the valuation at the time of the investment, the Series D investors will make more than their percentage ownership, and the founders will make less than their percentage ownership. In other words, when your investors have liquidation preferences, your percentage ownership isn't always what it looks like on paper (or in a capitalization table, to be exact).
Sometimes, investors want "participation rights". In the case of "participation rights", the investors would be entitled to the return of their entire investment prior to the distribution of any proceeds to the common stockholders. However, the preferred stockholders would then also be treated like a common stockholder and would share in the remaining proceeds. If our company sells for $75 million, the Series D investors would get their $10 million out first, and then get their 10% share of the remaining $65 million for a total return of $16.5 million ($10 million + 10% of $65 million).
There is also a concept called a "multiple". Where founders and employees can get really hurt is when preferred stock owners have a 2x or 3x multiple. If our Series D investors have "3x liquidation rights, participating", they would be guaranteed $30 million back (3 times $10 million) and take 10% of the remaining $45 million. The founders would make $15.4 million. Instead of their 34% share, the founders only get 20%. So, before you agree to any liquidation multiple or participating rights, you should run a few models to understand how much you and the other founders will receive based on various liquidation scenarios.
Because of the preferences, the price or market value of common stock is typically much smaller than that of preferred shares -- especially in the early days. Because common stock is worth less than preferred stock, your percentage ownership is often meaningless. This is often evidenced either by a 409(a) valuation in the USA, or the market price of common stock when sold to a third-party. Preferences generally expire at an IPO, at which time preferred stock converts into common stock. At that point, common and preferred shares have the same value.
In summary, valuations, multiple rounds of funding, option pools, reverse vesting, pro-rata rights and liquidation preferences can all have a dilutive effects on startup founders. As a founder, it can be difficult to predict or plan how much dilution you will suffer along the way. As with everything, the devil is in the details -- and hopefully this blog post helped you be a bit smarter about raising money and negotiating term sheets. In general, I don't think founders should worry about dilution too much but that is a topic for a future blog post ...