If it appears that venture capital is increasingly looking at the public sector market landscape, including defense, as a place to be, then these statistics may confirm that the answer is “yes”.
The amount of investment capital that has gone into venture-backed defense technology startups has doubled to $33 billion in 2022 from the $16 billion raised in 2019, according to a presentation given Wednesday at the Professional Services Council’s annual Vision Conference for industry- and government leaders.
Artificial intelligence, autonomy and space are among the technology areas highlighted by session host Jen Chaquette as of great interest to investors looking at early-stage companies showing promise.
Venture investors are mostly high risk and high reward. They focus on rapid growth in all their investments in young companies.
Startups can also scale quickly when they find success, which can lead to more capital being raised from investors who pick up on what these companies are doing.
But as panelist Mikhail Grinberg warned attendees in Arlington, Virginia, “The budget will not deliver the kind of growth” that this group of investors typically wants to see in portfolio companies.
Which means that in the defense and government market, investors are instead focusing on new and more commercially minded companies that are perceived as being able to take market share from others.
Tier one companies often have several billion dollars in capital from their investors to work with.
Grinberg identified the long-standing, traditional state market actors as those in the second category.
Or as he also characterized the group of companies that were hunted: “A lot of it sits in this space and space likes it.”
“They (VCs) believe that because of the inability to deliver more growth, the fact that our industry has reached a certain dominant design and maturity of the basic industrial structure, that it is ripe for disruption,” Grinberg added .
Commercial disruption across the entire public sector landscape may have been inevitable in retrospect. Co-panelist Frank Finelli said that in 1989 at least half of all scientific funding in the United States came from the federal government.
Fast forward to today and that share drops below 20%, Finelli said, adding that this means the government needs to lean on the technology development activity taking place across the wider commercial ecosystem.
Contractors whose leaders were in the room at Vision must then adapt the technology to programs, he added.
But many venture-backed companies have aggressive financial milestones to hit and face the dual challenges of booking commercial and government contracts to meet their obligations to investors.
They also need to be at a certain scale and critical mass of financial and human resources to meet the demands of their current and potential government customers, plus to develop and scale the technology.
“It costs a lot of money, and then they burn through the money they got from investors, and at some point they have to go back to the markets,” Finelli said. “The problem is that in these markets today there are few methods of getting that money.”
Venture credit is non-existent due to the failures of Silicon Valley Bank and other connected financial institutions like SVB, initial public offering volume remains low, and going back to the existing investor base often means presenting a changed plan for the company.
But one venture investor stands alone as the “single, biggest” in the government space, as Anita Antenucci pointed out: urgent operational needs identified and funded by the US government.
“There’s no substitute for that, and that’s what investors are really chasing,” Antenucci said. “They’re taking more effort than most have been willing to take in the past to understand what that need is.”
She presented two scenarios for the participants to consider. One is that if venture capitalists are right and willing to fund independent research and development or other similar concepts against that need, then the economics change for a US government that can wait to grant more funding later.
But a potential miscalculation by investors would mean they weren’t properly modeling the revenue from government programs, she said.
“This is one of the reasons why venture capital has been so minimally available to defense and government companies for so long,” Antenucci said.
A more conservative approach to venture capital investment in the space seems the most likely scenario at this point, according to Antenucci.
“You’re going to see savvy investors in the space stick to slightly less aggressive bets on the sector because they know things are materializing a little slower.”