Pentagon Balks at Venture-Backed Startups

"Venture capitalists have poured over $100 billion into U.S. defense-technology startups since 2021, banking on government interest in upgrading the military. Persuading the Pentagon to buy from Silicon Valley has proved difficult.

Washington and Silicon Valley have for years tried to forge a more lucrative partnership, and the rise of China and conflicts in Ukraine and Israel showcasing modern technology have made military leaders more anxious to modernize their arsenals. At the same time, many entrepreneurs in Silicon Valley, who historically have shunned military work, are increasingly enthusiastic about becoming a part of the country's war infrastructure.

Reflecting the new rhetoric of mutual benefit, there have been more venture-capital luncheons and salons in Washington, D.C., and Silicon Valley tours by defense officials. There is one problem: Defense Department dollars haven't kept up.

Only a very small number of U.S. defense startups had more than $25 million in government orders last fiscal year, according to government data. Traditional defense contractors typically get billions of dollars from the Defense Department annually.

"If there is not a shift in the concentration of contracts still going to the top defense primes toward these new vendors, this VC investment will dry up," said Michael Brown, a venture investor with Shield Capital and the former director of the Defense Innovation Unit, the Silicon Valley outpost of the Defense Department.

Venture-backed companies were awarded less than 1% of the $411 billion Defense Department contracts awarded in the government's fiscal year through September, according to data compiled by Govini, a defense-software company. That is only a slightly larger share than in 2010 when venture-backed companies received a half percent of the $373 billion the department spent, when only a small number of startups were building military technology.

"If these companies don't win contracts at a size and volume greater than what they are getting, they are in trouble," said Tara Murphy Dougherty, chief executive of Govini, which also sells to the Department of Defense. "We risk venture looking at the defense market as a failed experiment."

The Defense Department said it is changing its buying habits and giving startups more opportunities when their tech passes muster.

"We have realized that we had an ecosystem that was very difficult to penetrate," said Thomas Browning, assistant secretary of defense for mission capabilities. "And we have done amazing work to open it up."

Last year, the department announced Replicator, an initiative to arm the military with thousands of autonomous systems by next year, which could offer a sales boost to startups. Its Defense Innovation Unit, set up in Silicon Valley nearly a decade ago to connect startups with military buyers, has been allocated more money, influence and prestige in the Pentagon.

"I wish we had gone much more quickly as a department to get where we need to go," said Doug Beck, the unit's director. Startups are still better positioned than ever to build a business selling to the Pentagon, he said. "We are absolutely on the right track."

Venture-capital investment in startups building defense technology exceeded $30 billion a year for the past three years, about five times what it was in 2016, according to PitchBook Data. About 100 new defense-tech startups have been founded in the U.S. in the past three years.

The gulf between what the Defense Department says it wants and how much it spends on startups is a problem of culture and bureaucracy, said executives and venture capitalists. The managers in charge of defense contracts say they don't want to risk going into business with an unproven startup whose tech isn't widely used and could go belly up.

Steve Bowsher, chief executive of venture-capital firm IQT, which invests in startups helping U.S. national security and is funded by the U.S. government, said the Pentagon has been slow to recognize that young, unprofitable companies can turn out excellent technology for the military.

To give themselves a fighting chance, startups are beefing up their presence in the capital.

Former Air Force officer Even Rogers visits Washington about twice a month to meet defense officials, policymakers and members of Congress to talk about his startup, True Anomaly, which is developing autonomous satellites and software for space defense. He started the company nearly two years ago, optimistic that the U.S. was ready to include small companies in big space missions.

The startup has spent about $50 million in the past year and a half. It has sold its software to the government but has yet to fly a satellite or sell one of them to the U.S. Space Force.

"It takes a long time for a defense company to build traction," he said." [1]

1.  Pentagon Balks at Venture-Backed Startups. Somerville, Heather.  Wall Street Journal, Eastern edition; New York, N.Y.. 26 Jan 2024: B.1.