VC phone home

VoIP provider Vonage last week snagged $200m in a series E round led by Bain Capital. In a post-bubble venture investing environment where less is more, why is this startup getting so much?

Venture capitalists are great at sniffing out new and exciting technologies, though as the dour experiences of the dotcom bubble have proven, telecommunications and consumer-facing companies aren’t necessarily surefire bets.

VoIP is the next big killer app.

Peter Barris, managing general partner, New Enterprise Associates

But last week’s whopping $200 million series E round for Vonage has put voice over internet protocol (VoIP) technology into the spotlight. Led by Bain Capital, and with participation from existing including venture capital firms New Enterprise Associates (NEA), 3i, Meritech Capita Partners and Institutional Venture Partners, the company’s latest financing comes less than one year after a $105 million D round held last August.

Is Vonage—and for that matter, the VoIP market—receiving more hype than it deserves?

“VoIP is the next big killer app,” insists Peter Barris, a managing general partner in NEA’s Virginia office. The firm came on as an investor with Vonage at the B round.

VoIP technology has only really taken hold in the marketplace over the last few years. In short, it allows users to place and receive Internet telephone calls with a standard ten-digit number through a broadband connection – cable or DSL – and a special telephone adapter.

Of course, making telephone calls over the Internet certainly isn’t anything remarkably new – the technology was already in use in the late ‘90s with dial-up computers, allowing users to make, for example, long-distance phone calls without paying long distance prices. But the services were primitive, at best, and the benefits of high-speed Internet were still not widespread.

Today, a number of other startups, not to mention traditional phone service providers and cable companies, are trying to elbow in on the space. As broadband has expanded to homes across the US, the VoIP providers now have a chance to capitalize on the growth. Research firm In-Stat/MDR projects at least seven million users in the US alone by 2008.

And Vonage’s venture backers are betting on that growth. Barris says the company has a great shot over its startup competitors because it entered the market early and has gained lots of momentum. “Barriers to entry are built over time through execution. It’s a scale game. Once you build scale, costs go down and your brand-building ability goes up.”

As for the large amounts of money Vonage is fetching—$408 million in total to date—Barris says the company needs that capital to expand its subscription base, calling features and customer support functions (VoIP piggybacks on existing phone and cable wires, and therefore does not require funding for infrastructure.) “We’re continuing to expand our marketing in order to build the brand. … The company is growing at a phenomenal rate and that’s not cheap.”

Nevertheless, VoIP does not necessarily spell the end of traditional phones as we know it. For one, broadband users who connect via DSL still need that landline. Also, 911 service is limited since an emergency call center cannot automatically detect where a call originates – since a VoIP adapter can be connected anywhere there is broadband service – and instead relies on an address form submitted by the VoIP user.

Though analysts expect the service to go mainstream in the near future, VoIP’s major competition will come from the cellular services, which already offer competitively priced packages with many of the same features included with the VoIP services.