Fear Not the Demise of Venture Capital Funding for Defense

Fatima Fokina

Is the sky falling on tech startups and venture capitalists eager to break into the defense sector? “Time is running out for Silicon Valley,” tweeted Katherine Boyle, a partner with Andreessen Horowitz, the day before last year’s Reagan National Defense Forum. She went on to say: “After five years of [the Defense Department] saying ‘we want to work with the best startups,’ we have, at most, two years before founders walk away and private capital dries up.” Breaking Defense echoed Boyle’s sentiment, writing that the Davos-style gathering of defense leaders, politicians, and technology leaders was full of “an air of foreboding.”

A recent article in these pages by Shands Pickett similarly referred to some technology startups struggling to land government funding as “zombies” that can “just hang around until someone stops paying the web-hosting fees.” Pickett also pointed out that there has only been a single recent initial public offering (IPO) for a defense startup: Palantir.

 

 

I disagree with his viewpoints. Many organizations are working hard to get the best tech into government and ensure venture capital bets on startups pay off.

Take a look at my firm’s accelerator and government training programs: We are in the trenches working with companies and government decision-makers alike. Our portfolio includes more than 18 unicorns (of 115 companies) doing business in the federal marketplace, all of whom stand in stark contrast to commentators who suggest otherwise. Indeed, Dcode’s companies have raised almost $19 billion in venture backing.

We are not alone. In January, Andreessen Horowitz, where Boyle is a partner, announced the launch of its American Dynamism practice to invest in founders and companies that support the national interest.

There’s no doubt that government-facing startups face an uphill struggle. Most defense contracts are awarded to giant incumbents like Northrop Grumman and Booz Allen Hamilton. Even when a venture capital-backed company gets a foot in the door, they must bridge the infamous “valley of death” (the gap between the research and development phase and contract award) to get to the government equivalent of recurring revenue.

Making the Defense Department a better customer is indeed a heavy lift, but it can be done. Look at the work being done by AFWERX, the Defense Innovation Unit, and other offices that leverage Small Business Innovation Research contractsNone of them have the whole answer to bringing technology into government, but they’ve made significant progress towards an improved system. These programs are full of motivated people who want to fix the problem – and should be supported. We know because we work with them across a range of issues.

This is good work worth doing. Here are three perspectives for venture capitalists, tech companies, and government stakeholders to consider as they work to bridge the gap between Silicon Valley and Washington.

Getting to a Program of Record is Rarely Realistic

The narrative of the Breaking Defense article suggests that it’s up to the federal government to act quickly to help startups overcome the valley of death so they can get to a program of record quickly — before venture capital finds someplace else to go. This is a misguided argument and not the whole story.

Here’s why: Many investors do not know what is required to support sustainable business in the defense tech startup space. Getting to a program of record is not it. A program of record is a directed, funded effort in the U.S. federal budget — think fighter jet-scale spending. Startups will not compete in that space, nor should they try. Yes, there are the Palantirs, SpaceXs, and Andurils of the world — which between them have programs of record in the Defense Department and, in the case of Anduril, Customs and Border Protection — but that’s not where the vast majority of emerging companies should expect to be successful.

What’s the solution? One way startups can get their foot in the government door is to partner with a venture capital firm like ours with extensive experience in the federal space and that is willing to help the company chart a winning go-to-market strategy that ensures a consistent range of contract wins and recurring revenue.

This strategy can also open doors to a piece of the bigger pie. For instance, Lockheed Martin may have the program of record for the next-generation fighter jet and a startup can partner with it on the aircraft’s data processing or cybersecurity systems to get a foot in the door.

Bottom-Up, Not Brass-Down

Building a network is a critical part of being a good venture capitalist. Venture capitalists love to mingle, nurture relationships, and showcase their companies when hosting government bigwigs in Silicon Valley in the hopes of securing a big contract for their investments.

The problem? Senior military leaders are usually not the buyers — they have people for that. This top-down approach risks alienating users forced to use the technology whether they believe it is the best option for the mission or not. This poses a risk to the startup’s reputation.

In the bottom-up approach, venture capital firms that understand the federal government know they must go beyond schmoozing with senior leaders to open the front door for startups. They need to target and build relationships with the people who matter: the program managers who control the budget, contract officers who approve purchases, and the end users who pilot and use the technology every day.

Venture Capital Firms Are Serious About Defense-Focused Tech Startups

Time is not running out for Silicon Valley and venture funding for defense tech startups is not drying up. In fact, dual-use startups continue to find venture capital money and interest.

Read in full, Boyle’s Twitter feed offers an optimistic tone. The federal government is the largest buyer in the country — and Silicon Valley wants to get in on the act:

“…there’s good news! In fact, GREAT NEWS. It turns out that Silicon Valley heard the call from the Department of Defense and talented engineers want to build software for their country.”

And investors are backing them:

“Investors heard the call too: In 12 months, roughly $2 BILLION of private venture capital went to defense-focused companies.”

What of the fact that there has only been one major IPO in the defense market’s recent past? Pickett calls this “a hugely negative signal to venture capital firms about the value of the market.” In a sector with so much private capital, IPOs are an imperfect bellwether of defense-focused innovation. For example, SpaceX has a valuation of over $100 billion, much larger than Palantir’s roughly $21 billion market capitalization, and SpaceX was only part of the $14.5 billion private investment into space startups in the past year. Anduril reached a valuation of $4.6 billion in just four years without going public.

The federal market isn’t easy to navigate. Pickett’s right on that: We do need to protect contracting officers and program managers and reward them for taking smart risks. The Defense Department needs America’s leading technologists on its side.

But to get there, tech companies will need to smartly leverage the government’s forward leaning programs and partner with an investment firm that understands the government, its missions, and how it buys. Ultimately, understanding each of these perspectives can help companies break into and scale in the federal marketplace. Time isn’t running out. Innovation is in the air.

 

 

Rebecca Gevalt is a general partner at Dcode Capital, a venture capital fund investing in commercially successful tech companies that can improve the way the government serves and protects Americans. Previously Dcode’s managing director of technology, Gevalt built and operated Dcode’s accelerator program. She also launched Dcode’s government business to teach government stakeholders how to find and contract with nontraditional tech companies. Prior to Dcode, Gevalt worked at the CIA for more than a decade, and for some of those years, she worked with In-Q-Tel to bring novel tech startups into the national security space.

Image: Marine Corps Lance Cpl. Jose GuerreroDeleon Jr.

Fear Not the Demise of Venture Capital Funding for Defense

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