Venture still calling on VoIP

Despite a disappointing IPO for Vonage, VCs are still pouring money into internet-based telephony. Dave Keating reports.

When Mark Spencer founded Linux Support Services in 1999, he envisioned a company that would provide basic contract support for the open-source operating system Linux, a system which enables anyone to modify its source code. At the time, Spencer did not have the resources to purchase a private telephone exchange for his new company, so he decided to create one from scratch. He called his new internet-based creation Asterisk.

When the US economy entered a period of recession in 2001 and demand for his company’s Linux services dried up, Spencer decided to shift his focus to Asterisk, the internet-based private telephone exchange he had developed. The company was renamed ‘Digium’ in 2002.

David Skok, Matrix Partners

Spencer and other entrepreneurs like him were on the cusp of a monumental trend that many analysts are now saying will transform modern telecommunications. Voice over Internet protocol, or VoIP, has been one of the biggest buzz words in venture capital the past few years. The technology, which allows users to place and receive Internet phone calls with a standard ten-digit number through a broadband connection, has seen a steady stream of investment since VCs pumped $200 million into VoIP provider Vonage in May 2005.

That investment, led by Bain Capital, initiated a mad rush to invest in the new technology, and many investors began to question whether investors were putting the cart before the horse. Vonage’s disappointing IPO this past May, which has since seen shares plummet from $17 to less than $7, has made many industry observers caution that VoIP may be a losing horse. Investors have complained that the Vonage is unprofitable, has high customer acquisition costs, and faces tough bundle-ready competition from large cable and phone providers like Verizon and Comcast, which are quickly entering the VoIP race. But far from giving up on VoIP start-ups, VCs are only increasing their interest.

Digium, for instance, just received $13.8 million in series A financing from Boston-based Matrix Partners. The move is a big vote of confidence in the private branch exchange (PBX) technology that Asterisk uses to provide telephone service to businesses. The confidence is not unwarranted. Although Digium is now competing with much larger players in the battle to provide internet-based telephony services to businesses, the company has been growing by 100 percent a year and has been profitable since 2002.

“There is no question or doubt that [VoIP will become essential] unless companies want to pay high prices for something they could get for free with VoIP,” says Matrix general partner David Skok. “You can connect your global branch offices for free via the internet. And you can make each office part of the same system.”

Matrix isn’t the only firm showing confidence in the future of VoIP despite the disappointing Vonage IPO. Other recent investments this summer have included enterprise VoIP platform LignUp Corp’s $9.8 million series B financing from VCs including Intel Capital, an undisclosed series B funding of VoIP services company BandTel by Seagrove and a $15 million series C financing of VoIP services provider Convergence by Globescan Capital Partners. Earlier this week Ritchie Capital Finance announced it has closed $8 million in debt financing to hosted VoIP provider AccessLine Communications.

You can connect your global branch offices for free via the internet. And you can make each office part of the same system.

David Skok, Matrix Partners

There’s no doubt that there isn’t a shortage of VoIP start-ups to choose from, but how does one separate the wheat from the chaff? Matrix, which was also involved in the sale of VoIP provider JBoss to Red Hat for $420 million in April, has had a pretty good track record of success. David Skok was a lead investor and a board member at JBoss, helping the company go from a small startup to a successful acquisition.

Skok says he identified Digium from its many competitors because of its ability to work with existing phone lines. Asterisk’s competitor Pingtel, for instance, operates under a different system, session initiation protocol (SIP), and is not able to work with existing analog technologies.

“Pingtel is only a VoIP and SIP-based implementation,” Skok says. “Asterisk works with TDM [Analog] technologies. Since everyone has TDM technologies, customers will find it easier to migrate to VoIP without abandoning their current technologies.”

It remains to be seen who will emerge the victor in this telecommunications revolution; the small start-ups or the established service providers. Some speculate that the biggest competition for VoIP could come from cell phone providers, which offer many of the same features as the VoIP services. For the time being, however, it appears VCs are charging full speed ahead into the technology.