High-speed Ethernet service providers snare cash

Yipes Communications and Telseon do what many start-ups have found difficult in recent months: They are capturing the hearts of venture capitalists and corporate investors.

3 min read
Yipes Communications and Telseon, two fledgling communications service providers, have done what many start-ups have found difficult in recent months: They've captured the hearts of venture capitalists and corporate investors.

San Francisco-based Yipes closed a $200 million round of funding on Monday from Intel, Soros Private Equity and several investment banks. The company received $139 million of the money in September and the remaining $61 million at the end of January. Telseon, of Englewood, Colo., followed Tuesday with $100 million in equity investments and an additional $75 million in equipment supplier financing from, among others, the telecommunications investment arm of DLJ Merchant Banking Partners, Cabletron Systems, Foundry Networks and U.S. Bancorp Piper Jaffray.

Both companies provide gigabit Ethernet technology, a high-speed networking service. Because Ethernet technology has been in use for years the gear is inexpensive, which allows carriers such as Yipes, Telseon and other competitors to provide high-speed network connections for businesses at low prices. Business customers can receive greater bandwidth at lower costs than via traditional communications providers such as the Baby Bells.

"The metro market is one area of communications that is getting funding," said Andy Rush, chairman of DLJ Global Communications Partners, a communications investment unit of Donaldson, Lufkin & Jenrette and a Telseon investor. "People are more selective, and VC firms are scrutinizing these companies more closely...But (gigabit Ethernet) has a lot of excitement attached to it."

These hearty rounds of funding are impressive at a time when many companies are hard-pressed to attract even minimal backing. Venture capitalists are scrutinizing start-up investments as never before, and yet the gigabit Ethernet providers have garnered massive rounds of funding.

However, some industry insiders say that, in exchange for the cash, Telseon--and to a lesser extent Yipes--were forced to give up more equity in their companies than executives might have hoped for in better times.

"(Telseon) came close to not getting funded," said Bart Schachter, a general partner at Blueprint Ventures, which has invested in several communications companies and looked at the Telseon deal early before opting out.

In exchange for the funding, Telseon had to surrender a stake in its company as much as five times larger than executives originally had planned, a development that generated a much lower valuation for the company, Schachter said. Venture capitalists now believe, he said, that if the valuations of most public companies have fallen as much as 95 percent from their 52-week highs, then private companies also should be down comparably, if not more.

"But when the price became right, everybody jumped in," Schachter said. "And it was at a fraction of what (company executives) expected."

Telseon executives declined to comment on their valuation.

"It's an incredibly tough market right now," said Vesna Swartz, vice president of marketing for Telseon. "The fact that we were able to get this financing is a testament to two things: We have a strong technology differentiation with our proprietary software...and we have an incredibly focused, almost militarylike ability to execute."

For their part, Yipes Communications executives steadfastly defend the company's valuation, saying Yipes was not forced to give up an inordinately large stake in the company in exchange for funding.

"The terms didn't change. Our valuation did not decline from September to January," said Yipes Chief Financial Officer Robert Valdez. "Our valuation has gone up very substantially and has not come down in this market. The largest shareholder group by far is the employees, officers and founders of Yipes Communications."

Regardless, many industry experts have speculated for some time now that venture capitalists and corporate investors will bet on fewer companies, giving them larger rounds of financing as more investors bestow cash upon the strongest start-ups.

Yipes and Telseon have been busy building their networks, both companies serve 20 of the nation's largest cities, and they have signed partnership pacts with significant carriers. For example, Telseon has resale deals with 360networks and Level 3 Communications.

"There's something to the low cost of Ethernet equipment. For data or Internet access, they can offer more bandwidth and at a lower cost than, say, a T1 or T3 (connection)," said Shin Umeda, an optical industry analyst at the Dell'Oro Group, a networking market research and consulting firm. "And a lot of it has to do with them being already established and early to market. They are well along."

Yipes and Telseon "were earliest to market, and they were able to build their infrastructure and business models early," Umeda said.