Fear Not the Demise of Venture Capital Funding for Defense

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

A recent article on these pages by Shands Pickett called some tech startups struggling for government funding “zombies” who can “just hang around until someone stops paying the web hosting fees.” Pickett also pointed out that there has only been one recent initial public offering (IPO) for a defense startup: Palantir.

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

Take a look at my company’s accelerator and government training programs: We’re in the trenches, working with both business and government decision makers. Our portfolio includes more than 18 unicorns (out of 115 companies) operating in the federal market, all in stark contrast to commentators who claim otherwise. In fact, Dcode’s companies have raised nearly $19 billion in venture backing.

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

There is no doubt that government-focused startups face an uphill battle. Most defense contracts go to established giants like Northrop Grumman and Booz Allen Hamilton. Even if a venture-backed company gets a foot in the door, it must bridge the infamous “death valley” (the gap between the research and development phase and contract award) to achieve the government equivalent of recurring revenue.

Making the Department of Defense a better customer is indeed a daunting task, but it can be done. Check out the work of AFWERX, the Defense Innovation Unit and other offices using small business innovation research contracts. These programs are full of motivated people who want to fix the problem – and should be supported. We know because we work with them on a number of issues.

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

Arriving at a record-breaking program is rarely realistic

The narration of break defenses The article suggests that it’s up to the federal government to act quickly to help startups navigate death valley so they can get to a record-breaking program quickly — before venture capital finds somewhere else to go . This is a misguided argument and not the whole story.

Here’s why: Many investors don’t understand what it takes to support a sustainable business in the defense technology startup space. Getting to a record program isn’t. A record program is a focused, funded effort in the US federal budget—think fighter-jet-scale spending. Startups will not compete in this space and should not try. Yes, there are the Palantirs, SpaceXs, and Andurils of the world — who share programs in DoD and, in Anduril’s case, Customs and Border Protection — but that’s not where the vast majority of aspiring companies should expect to be successful.

What is the solution? One way for startups to get their foot in the government door is to partner with a venture capital firm like ours that has extensive federal experience and is willing to help the company design a successful go-to-market strategy that delivers a consistent offering assured of contracting and recurring revenue.

This strategy can also open doors to a piece of the larger pie. For example, Lockheed Martin might have the program of record for the next-generation fighter jet, and a startup might work with them on the plane’s computing or cybersecurity systems to get a foot in the door.

Bottom up, not brass down

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

The problem? High-ranking military leaders aren’t usually the buyers — they have people for it. This top-down approach risks alienating users who are forced to use the technology, regardless of whether they believe it is the best option for the mission or not. This endangers the reputation of the startup.

Taking a bottom-up approach, venture capital firms that understand the federal government know they need to go beyond poking around with senior executives to open the door to startups. You need to purposefully build relationships with the people who matter: the program managers who control the budget, the contract staff who approve purchases, and the end users who test and use the technology on a daily basis.

Venture capital firms are serious about defense-focused tech startups

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

read in full, Boyle’s Twitter feed offers an upbeat tone. The federal government is the biggest buyer in the country – and Silicon Valley wants to get involved:

“…there is good news! Indeed, BIG NEWS. Turns out Silicon Valley has heard the call from the Department of Defense and talented engineers want to build software for their country.”

And investors support them:

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

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

The federal market is not easy to navigate. Pickett is right about that: we need to protect contract officers and program managers and reward them for taking smart risks. The Department of Defense needs America’s leading technologists on its side.

But to get there, tech companies need to make intelligent use of the government’s forward-looking programs and partner with an investment firm that understands the government, its missions, and the way it buys. Ultimately, understanding each of these perspectives can help businesses gain traction and scale in the federal marketplace. Time is not running out. Innovation is in the air.

Rebecca Gevalt is a general partner at Dcode Capital, a venture capital fund that invests in commercially successful technology companies that can improve the way government serves and protects Americans. Gevalt, previously Managing Director of Technology at Dcode, built and ran Dcode’s Accelerator program. She also started Dcode’s government business to teach government actors how to find and deal with non-traditional technology companies. Prior to Dcode, Gevalt worked at the CIA for more than a decade, and some of those years worked with In-Q-Tel bringing novel tech startups to the national security space.

Image: Marine Corps Lance Cpl. Jose Guerrero Deleon Jr.

https://warontherocks.com/2022/05/fear-not-the-demise-of-venture-capital-funding-for-defense/ Fear Not the Demise of Venture Capital Funding for Defense

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