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Jeffrey Citron Has Launched Two Successful Startups


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Would You Buy A Phone From This Man? At Age 34, Jeffrey Citron Has Launched Two Successful Startups

September 7, 2004

By Stephanie N. Mehta

In the past 18 months streams of moneymen, technology analysts, and journalists have made their way to a drab office building in Edison, N.J.Here a tiny upstart called Vonage is upsetting the telecom industry by selling cheap phone service that travels over the Internet. It is an intriguing concept, but the curious don't come to check out Vonage's dumpy digs or even its technology, which turns out to be some software and a bunch of servers and computer screens. No, they trek to this middle-class suburb 30 miles south of New York City for one reason: to scrutinize Jeffrey A. Citron, Vonage's ferociously ambitious CEO and potentially telecom's next big thing.

You may recognize Citron's name for a couple of reasons. He is, at 34, a fixture on FORTUNE's 40 Under 40 survey of the nation's richest young Americans. This year he clocks in at No. 11, having amassed some $346 million in wealth, mostly from his previous ventures, Island ECN, a stock-trading system, and Datek Online, an Internet brokerage. Or you may remember Citron in a less savory context: Early last year the Securities and Exchange Commission charged him with illegal trading—essentially manipulating a trading system meant for small investors for his personal gain. Citron paid a $22.5 million penalty—one of the largest ever levied by the SEC—to settle the charges and admitted no wrongdoing. Yet he still finds himself in the unpleasant position of answering questions about his character. Perhaps even more frustrating, he has had to prove to nosy visitors and financial backers that he is the real deal—a truly gifted entrepreneur whose business successes aren't the product of sheer luck or, worse, deceit.


That puts a lot of pressure on Vonage (pronounced VON-ij), Citron's latest and possibly most ambitious foray, one in which he has invested $70 million of his own money. Founded three years ago, Vonage has become, to the surprise of many telecom executives, one of the nation's leading purveyors of Internet calls, sometimes known as Voice Over Internet Protocol, or VOIP, for consumers and small businesses.

Today it has 250,000 customers—mostly tech-savvy types eager to stick it to their local and long-distance phone companies—but Citron and his backers think the company has the potential to be a significantly bigger player in the telecom world, specifically a $1-billion-a-year business. (That is indeed a grand vision. Last year's sales were less than $30 million; Vonage's CFO says the firm would be profitable today if not for marketing costs.)

Citron says Vonage is a lot like Datek, which used the Internet to change the way people traded stocks and the price they paid to execute trades. Similarly, Vonage's Internet-based phone network (which Vonage rents) is much, much cheaper to operate than that of a traditional phone company, allowing Vonage to sell unlimited local and domestic long-distance phone service for a mere $30 a month. "I'm very fortunate. Most people are only given one opportunity to do something transformative," Citron says. We are sitting in Vonage's headquarters at a conference table made up of four plastic folding tables. Citron, baby-faced and bespectacled, is halfheartedly trying to sound humble about his entrepreneurial track record. "I'm very lucky," he says, adding, "I have been able to start two transformative businesses, Island and Datek." And now he's hoping to transform yet another business: "Vonage's strategy is to revolutionize the telecommunications industry," he says. The guy certainly has moxie.

There's no question this is a story about second acts. But it's also a tale of second chances. A lot of people and companies are backing Citron, despite his checkered past.

They are not doing so lightly: New Enterprise Associates, a savvy, white-shoe venture capital outlet that backed UUNet—now part of MCI—and 3Com, spent almost a year sniffing Citron out before agreeing to invest an initial $12 million in Vonage in November 2003. Three months later NEA ponied up $7 million more, and this summer it poured an additional $40 million into Vonage, making it the second-largest owner of the company, after Citron. To win over the financiers, Citron had to convince them he had grown. "The most important thing we saw in Jeffrey was his ability to adjust to changing circumstances," says Harry Weller, a partner at NEA who sits on Vonage's board. He says Citron, for example, heeded the board's advice on pricing the Vonage service, even though he disagreed. (Eventually the board decided Citron was right.) "He used to be a visionary type. He's become a leader."

He's certainly become an important and polarizing figure in the staid world of telecom in a relatively short time. For every two industry pundits who think he's a genius, there's one who wonders if he is just a flash in the pan. Just about everyone believes he has great instincts. Citron has spent almost half his life honing his business skills.

After his graduation from Staten Island's Port Richmond High ("It wasn't a great school," he says), college just didn't appeal. Citron says that back then he had a "passion for working on Wall Street." He ended up getting a clerical job at Datek Securities, a bare-bones day-trading outfit in Brooklyn—not exactly Wall Street, but close enough for a 17-year-old kid. At Datek, Citron displayed a trader's good instincts—he has said he made his first $1 million by the age of 21—and an entrepreneur's self-assuredness: He asked out one of the firm's part-time employees, then a college student, for nearly a year before she agreed to date him. She is now his wife.

Financially secure and itching to venture out on his own, Citron left Datek in 1992 to pursue an electronic stock-trading network that eventually became Island—a trading system that allowed institutions and individuals to execute trades with each other directly instead of going through the middlemen known as market makers. He returned to Datek in 1998, bringing Island with him. Island spawned Datek Online, an online brokerage that enabled regular Joes to execute instant stock trades for ten bucks. It was the height of the dot-com era, and on message boards and in the pages of the press Citron was hailed a revolutionary.

But Citron didn't make many friends at the big, established brokerage houses that were losing share to Datek and Island. Nor did he win over the SEC, which launched an investigation into Datek, Citron, and a handful of other principals for a host of securities violations, including allegations that they created a raft of individual accounts in the names of friends and family members to make stock trades on a special service for small Nasdaq investors. The system, the Small Order Execution System, or SOES, was designed for use by small retail investors. At the time, brokers were barred from using the system for their own trades. Nasdaq has since replaced SOES with a system that everyone, including professionals, can use to make trades of all sizes.

Amid the inquiries, Citron resigned as CEO of Datek in 1999. And for a while nothing happened. Citron sold his stakes in Datek and Island for $225 million (the companies were eventually sold to Ameritrade and Reuters, respectively, for a total of $1.8 billion) and took a year off to travel to such places as New Orleans, Disney World, and Cabo San Lucas with his wife, Suzanne, and their daughter, a toddler at the time. He played golf. The Citrons had a son. Finally, in January 2003, the SEC issued its complaint, and Citron agreed to pay a $22.5 million settlement. Citron, whose deal with the SEC precludes him from denying—or admitting—any wrongdoing, will say only, "It is what it is."

After all that, it takes a lot of nerve to think you can come back. And not just come back, but take on a 100-year-old business using a technology that many established competitors deem not ready for primetime. It also takes unwavering self-confidence to face down naysayers who think your idea simply won't work. Citron, it turns out, has nerve and confidence to spare. Jeff Pulver, an early proponent of VOIP, sought a meeting with Citron back in the summer of 2000. Pulver thought Citron might want to invest in one of his telecom startups, and one of Pulver's associates offered to send a car to fetch him. Citron arranged his own transportation. "Jeffrey did make it a point to make sure we knew he arrived by helicopter," Pulver recalls drily. Citron agreed to make a small investment in Pulver's Voip venture, a sort of exchange for surplus Voip minutes. Several months later, however, Citron decided there wasn't big money to be made in the exchange—but he did want to pursue a business selling Voip directly to consumers.

The problem was that Voip was considered a quirky niche business. A few geeks used their computers and microphones to make Internet calls to other geeks with computers and microphones, but that was about it. The big phone companies were testing Voip in their labs, but no one had figured out how to offer the service to consumers.

Citron brought an outsider's clarity to the business. He and Louis Holder, Vonage's product-development executive, sat around with a couple of telecom experts brought on to help them better understand the traditional phone networks Citron would have to compete with—and connect with to complete phone calls. It was a total clash of cultures.

Holder recalls, "The Bellhead guys would say, 'You can't do that,' and Jeff would say, 'Well, why not?' " Citron, Holder says, kept hammering away until he got the answer he wanted: Vonage's business plan was technically feasible.

Still, Citron's scheme wasn't exactly a slam-dunk. His idea was to run phone service over high-speed Internet connections such as cable modems and DSL. Back in 2001, broadband service was in its infancy, and many tech executives questioned whether consumers would really want broadband in the home. Citron boldly bet they would. He turned out to be right. Today there are more than 25 million broadband households in the U.S., up from fewer than ten million when Vonage started.

Citron has also created a phone company that relies almost entirely on other people's infrastructure. To use his service, customers need broadband in their homes (purchased from the cable or phone operator). You hook a special device up to your broadband and phone that basically prepares your phone calls for travel on Internet networks, which Vonage leases from companies such as Global Crossing.

Vonage competitors at the phone and cable operators find this setup horrifying because Vonage has so little control over the quality of the customer experience. If someone has a bad broadband connection, say, it would affect the quality of his Vonage service. But in some ways that's the beauty of Vonage. Rather than wait around for everything to be perfect, as his competitors have, Citron leaped in with a best-effort solution. "Citron didn't get sidetracked with this box or that software," says Neal Shact, CEO of CommuniTech, a Voip supplier. "He put together a turnkey solution for customers."

Today the Vonage brand has become practically synonymous with VOIP. The root of its name, VON, is short for "Voice on the Net." Some of its customers are rabid proponents of the service, extolling its virtues—such as the ability to pick your own area code and have voicemail messages delivered to your work e-mail account—at cocktail parties and summer barbecues.

Of course, plenty of pioneers have dominated their fields—Netscape in web browsers, TiVo in time-delay television—only to get trampled by bigger, deeper-pocketed rivals. And the same thing could very well happen to Vonage. Earlier this year AT&T launched CallVantage, a Vonage-like service that Ma Bell sells in 170 metropolitan markets. (Shortly after AT&T unveiled a $20-a-month promotional rate, Vonage trimmed $5 off its monthly service fee.) Baby Bells Verizon and Qwest are jumping into VOIP. And cable operators are coming out with their own versions of Voip service, which they will package with video and broadband services (see chart: Taking On the Giants).

Since a customer needs to have broadband to sign up for Vonage anyway, why not just get the whole bundle—voice, video, and data—from one provider? Put another way, why buy TiVo when you can record TV through your cable box? "Everything Vonage is doing can be replicated by others using off-the-shelf technology," says Jon Arnold, an analyst with Frost & Sullivan. "I don't think it has a sustainable technological advantage."

Citron is a study in contrasts. He didn't attend college, yet often he is the smartest guy in the room. He has developed, almost self-consciously, very refined tastes in wine and art—he served on the board of the Montclair (N.J.) Art Museum for six years and considers himself a serious collector—yet he seems perfectly happy to sit in a grungy cubicle at Vonage and eat the cafeteria-style hot lunch the company provides its employees each day. (The cubicle is a step up: Citron used to sit at a folding table in the middle of the company's open-plan offices until the office manager made him move.) He does occasionally display a gazillionaire's eccentricity. His charity, the Charles Lafitte Foundation, which gives money to art and children's programs, is named after one of the Citrons' four Labradors.

He also is an extremely tough—some would say ruthless—businessman. In 2002, Vonage sued Citron's former business partner and a few ex-employees. The suit accused the former employees of starting a rival company—with the intent to destroy Vonage—and sought permission to confiscate their computers, PDAs, and other computing gear to look for evidence. Vonage dropped the lawsuit a few months later, but Citron quickly gained a reputation as an executive who would protect his business at all costs. More recently Citron has sued archrival AT&T, claiming its CallVantage service sounds too similar to the Vonage brand. The two companies subsequently settled.

Citron admits he is a tough boss but prefers to think of himself as impassioned. "I have a tremendous passion for what I do," he says. "I don't know any other way. I find it hard to make room for other things in my life. I'm not sure that's a good thing." He certainly is tireless in his promotion of Vonage and VOIP. He has delivered dozens of presentations to financial analysts and academics. He has testified before Congress and the Federal Communications Commission, urging regulators to keep their mitts off the fledgling business of Internet calls. No speaking opportunity is too small for Citron: He's giving a speech to the Trenton, N.J., Rotary Club this fall.

All this activity creates the impression that there's more sizzle than steak to Jeffrey Citron. "Some clients have said, 'The only reason we've even heard of Vonage is because the company puts out two press releases a day,' " says Ford Cavallari, senior vice president of Adventis, a telecom consulting outfit in Boston. Adventis invited Citron to speak at its advisory board meeting this spring (Citron, of course, accepted), and Cavallari, who hadn't previously met Citron, was pleasantly surprised. "He was very well versed on the industry, the regulatory environment, the technology."

A few years ago, when NEA was figuring out whether to give Citron a shot, Harry Weller paid him a visit. Weller brought with him Peter Barris, an NEA senior partner who had made some of the firm's biggest telecom investments; Michael O'Dell, former chief scientist of UUNet; and John Sidgmore, who had briefly served as CEO of WorldCom. The four men quizzed Citron for hours about Vonage's technology and business plan. "We couldn't stump him," Weller says. Weller then met privately with Citron. "Quite honestly, we got into an argument about several things," Weller recalls cheerfully. "Valuation, the way the company should be run ... But I realized I could work with Jeffrey under even the most contentious situations."

If Citron hangs on, he'll be one of the few outsiders to break into the notoriously insular but still dominant U.S. telecom club. Most industry executives cut their teeth at AT&T or one of Ma Bell's offspring. The entrepreneurs and outsiders who flooded the phone business in the 1990s are gone now; many of them left in disgrace. (Bernie Ebbers, anyone?) But Citron says outsider status isn't an automatic impediment in telecom. "Mike Armstrong, [Clark] McLeod, Winnick in particular—they were chasing stock price," he muses, ticking off the names of the former CEOs of AT&T, McLeodUSA, and Global Crossing, respectively. "Their companies didn't fail because they were outsiders." The irony of a 33-year-old punk chastising his predecessors for greed is lost on Citron, but then he has other things on his mind.

What will keep Vonage from becoming the next telecom flameout? Citron believes he has the answer: better customer service. The company's 300 customer-service representatives all work at company headquarters—no offshoring for Citron—and go through constant training. Vonage doesn't lock its customers into service contracts, and when it lowered prices earlier this year, Vonage automatically shifted existing customers to the lower price. Citron also believes his company is simply more nimble and creative than the competition. The company is prepared to roll out a new gadget that shows some groove and could give it an edge. In time for the holidays, Vonage is going to introduce a wireless phone that has Vonage's Voip box built right in. Customers with Wi-Fi networks in their house can simply turn on the phone and get online, using a device that looks remarkably like a regular cellular phone. Vonage's vendors helped create the phone, but the idea emanated in-house.

It is this kind of solid progress that keeps Citron's backers doubling down on Vonage and its founder. In addition to NEA, venture capital firms 3i and Meritech Capital and Vonage insiders invested another $105 million in mid-August. "Many people keep saying Jeffrey is going to fail, and it just hasn't happened," says Harry Weller, the NEA partner. To hear Citron tell it, it is as if he aims to succeed out of sheer will. "If this were to fail, it would be a real disappointment to me. I have a lot of emotion invested," he says. "I have a lot of capital invested, too, that I don't want to see dissipate." This time around, Wall Street is rooting for Citron. After a drought of tech IPO activity (Google notwithstanding), CFO John S. Rego says calls from investment bankers seeking to take Vonage public are among the "top three" kinds of call he gets.

The financial community seems undeterred by Citron's SEC settlement—Rego claims he never gets asked about it when he speaks at investor conferences—and indeed, the terms of Citron's settlement don't preclude him from running a public company. But it probably wouldn't be a lot of fun having to rehash that information in red herrings and at every road show.

It may not be an issue for Vonage anyway. Many analysts believe the company will be bought by a cable operator looking to jump-start its phone business or an Internet provider aiming to add voice to e-mail and web services.

Citron and his team insist they are in the business for the long haul—they are going through the trouble of making sure the company's financials comply with the rigors of the new Sarbanes-Oxley Act, for example, something only public companies are required to do.

But if every company is for sale, the real question is, At what price? In the Adventis advisory board meeting Citron spoke at this spring, one attendee commented, "I'm not sure whether Jeffrey's business is worth $1 billion, $10 billion, or $100 billion." According to another attendee, Citron grinned broadly and replied, "I'm not sure what the right numeral is, but I like the 'billion' part." So must the investors who decided to give Citron a second shot.



 
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†AK and HI residents pay $29.95 shipping. ††Limited time offer. Valid for residents of the United States (&DC), 18 years or older, who open new accounts. Offer good while supplies last and only on new account activations. One kit per account/household. Offer cannot be combined with any other discounts, promotions or plans and is not applicable to past purchases. Good while supplies last. Allow up to 2 weeks for shipping. Other restrictions may apply.

1Unlimited calling and other services for all residential plans are based on normal residential, personal, non-commercial use. A combination of factors is used to determine abnormal use, including but not limited to: the number of unique numbers called, calls forwarded, minutes used and other factors. Subject to our Reasonable Use Policy and Terms of Service.

2Shipping and activation fees waived with 1-year agreement. An Early Termination Fee (with periodic pro-rated reductions) applies if service is terminated before the end of the first 12 months. Additional restrictions may apply. See Terms of Service for details.

HIGH SPEED INTERNET REQUIRED. †VALID FOR NEW LINES ONLY. RATES EXCLUDE INTERNET SERVICE, SURCHARGES, FEES AND TAXES. DEVICE MAY BE REFURBISHED. If you subscribe to plans with monthly minutes allotments, all call minutes placed from both from your home and registered ExtensionsTM phones will count toward your monthly minutes allotment. ExtensionsTM calls made from mobiles use airtime and may incur surcharges, depending on your mobile plan. Alarms, TTY and other systems may not be compatible. Vonage 911 service operates differently than traditional 911. See www.vonage.com/911 for details.

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