For many years, it was taken as a given that venture investing was fundamentally incompatible with defense technology.
Cripplingly long acquisition cycles — upward of 10 to 15 years for major weapons programs — and unfavorable economics of defense tech startup exits were frequently cited as two reasons why the math simply didn’t add up. Sometimes the objections wore moral garb: In 2018, a group of Google employees told CEO Sundar Pichai that the company should cease work on a Pentagon pilot called Project Maven because “Google should not be in the business of war.”
The times have changed. Indeed, it is likely not an overstatement to say that the relationship between U.S. defense and Silicon Valley is undergoing its most profound transformation since the 1950s, when Pentagon funding led to massive advances in computing, semiconductors and weapons systems.
Here, five venture investors describe this historic shift. Three of the investors separately use the word “generational” to describe the transformation: Jackson Moses, founder and managing partner at Silent Ventures, says defense tech is a “generational opportunity”; Jake Chapman, managing director of Marque Ventures, describes a “generational shift” of capital and wealth toward startups; and Josh Manchester, founder and GP of Champion Hill Ventures, talks about the country’s “generational competition” with China.
It is no coincidence that this word is repeated again and again. Spurred on by geopolitical antagonisms, a growing awareness that the U.S. defense industrial base is poorly equipped to keep the country competitive (despite being extraordinarily well capitalized), and changes within the Department of Defense have created new opportunities for venture-backed entrepreneurs — and the investors who fund them.
When one considers dual-use segments like space launch and biotechnology, the opportunities become even more expansive. PitchBook, which includes these segments and others in its analysis, found that defense tech VC activity topped out at $34.3 billion last year alone.
Of course, risks remain. You’ll hear from five investors on the complexities of defense tech investing, which sectors are over- (and under-) saturated, and whether venture dollars will help build the next U.S. prime.
We spoke with:
- Jackson Moses, founder and managing partner, Silent Ventures
- Jake Chapman, managing director, Marque Ventures
- David Ulevitch, general partner, a16z
- Raj Shah, managing partner, Shield Capital
- Josh Manchester, founder and general partner, Champion Hill Ventures
The responses have been edited for length and clarity.
Jackson Moses, founder and managing partner, Silent Ventures
What is your investment thesis for defense tech?
Defense tech is a generational opportunity best categorized as dot-com 2.0. It is the patient arbitrage of a massive market historically defined by inertia, occupied by imperfect legacy businesses, plagued by suboptimal public-private relationships, and hindered by entrenched structural deficiencies that incentivize improper behavior at the expense of national security. Silent Ventures believes investing in defense startups is an effective way for LPs to meaningfully diversify risk, support highly motivated builders, capitalize on asymmetric upside, and unequivocally eliminate the emerging narrative of a new global order.
It was long assumed that defense tech was not a suitable area for venture investing because it could never achieve the returns in timeframes limited partners are looking for. Why was that the case, and how different is the landscape now compared to five years ago?
Without re-litigating defense tech philosophy and ethics, a major reason LPs avoided this space, the short answer is that prior to 2022, many venture LPs pursued alpha in the form of proven generalist funds and unproven “emerging” managers. For most of this century, especially 2018 through 2021, LPs had to consider the historically high opportunity cost of participating in defense tech over generalist sectors. Explaining these trade-offs in 2018 would have proved a lesson in futility. However, for better (or worse), the 2022 “reset” served as a forcing function for LPs to revisit risk management and portfolio construction fundamentals.
With turbulent capital markets and global conflicts as the macro backdrop, sophisticated LPs chose to re-allocate capital into defense tech specialists. Whereas it was once a prerequisite to bootstrap A&D with minimal investment, exceptional defense tech founders now command a premium.
Defense tech investing has heated up: According to PitchBook, VC firms injected $7 billion into aerospace and defense companies through the first 10 months of last year. As more generalist VCs enter the space, what effect will this have on the defense tech ecosystem? In what way is the increase in generalist VCs making you retool your investment strategy?
Some storied generalists have indeed pivoted and advertised defense tech as the “next big thing.” These are well-intentioned firms, and I applaud more good dollars backing patriots developing products of substance. That said, A&D is inherently complex, shares few generalist analogues (look at DoD contracting vs. commercial ARR as a proof point), and requires years of honed, specialized expertise. Because of these substantial differences, early participants are protective of the defense tech ecosystem: Original investors shield founders and vice versa.
In general, defense tech participants are long-term strategists. We understand not all venture dollars are the same shade of green; we know unfair advantages don’t always stem from the largest institutions; and we have yet to see which generalists, if any, are tourists or are truly dedicated to national security. Until we collectively know more, the best A&D founders will continue to partner with specialist investors who helped lay the foundation when defense tech was (extremely) unpopular, many years back.
As for new entrant consequences, I suspect more A&D companies will receive funding at increasingly higher valuations and that failures will be more seriously scrutinized. However, this isn’t unique to defense tech.
National security means more than munitions. What are the most overlooked or undervalued defense tech segments, or ones most primed for growth, in the next 12 months? Conversely, are there any areas that are oversaturated?
Silent Ventures believes munitions, kinetics, and affordable mass are essential pillars of effective U.S. deterrence, or “peace through strength,” that are critically underfunded or mismanaged, depending on your prerogative. The root cause — magazine coverage — is an area I spend much of my time researching. I frequently meet with founders developing solutions across a hybrid stack that includes munitions, propulsion, manufacturing, supply chain and logistics.
It is unfathomable that Stinger, Javelin, and Harpoon missiles are in short supply. It is incomprehensible that, with an $857 billion defense budget, America must arm allies with cluster bombs instead of “dumb” artillery shells. This is an existential problem in need of immediate solutions. As for saturated defense verticals, I confidently speak for many VCs in asking entrepreneurs to please cease building new class 1-2 UAVs and collaboration and productivity platforms.
What role should nondilutive financing programs play as a company builds its cap table?
It really depends on the contracting vehicle. For example, I place zero premium on traditional nondilutive financing mechanisms like Phase I SBIRs and research grants. However, TACFIs and STRATFIs are a different story. As it pertains to the former, my reasoning is multifold:
- They are low dollar amounts and not difficult to obtain (i.e., not a strong PMF signal).
- Venture-scale businesses shouldn’t require them (i.e., premier startups solving hard problems will always attract more investment).
- A dual-use strategy can more effectively de-risk financials (i.e., focus on commercial GTM where possible).
- An emphasis on nondilutive funding, often pushed by inexperienced investors, can seriously jeopardize core business development.
Tactically, at this juncture in defense tech, very few startups can survive, let alone thrive, on government contracts alone (SBIR mills are not venture-scale investment opportunities). I prefer my companies primarily focus on commercial sales while running longer-term government partnerships in parallel. Ultimately, this means working with USG to establish a program of record.
The “valley of death” is a well-known risk for commercial companies selling to the government. How can startups bridge this gap before the dollars dry up?
Sophisticated defense entrepreneurs are extraordinarily savvy when it comes to revenue, burn, and runway. They are acutely aware of their budget constraints. They are also uniquely positioned to proactively avoid, or at least mitigate, existential risks derived from the “valley of death.”
The easiest way to avoid this proverbial trap is to employ a dual-use business model whereby private sector revenue (i.e., shorter sales cycles and feedback loops) subsidizes the time cost associated with onerous government contracting initiatives. That said, if an A&D startup is strictly focused on addressing USG pain points, it can work alongside DoD agencies DIU, AFWERX and DARPA, among others, to more efficiently source and secure government contracts.
Will venture help build the next U.S. prime? Will it look differently than today’s primes? The past 24 months have been a challenging economic environment, but rising geopolitical tensions have been something of a counter-boon for defense tech. Is defense tech due for a reset?
For better or worse, the word “prime” is associated with many unfavorable connotations. For many, prime evokes thoughts of rent-seeking, special interests, troubled technologies, cost overruns, and endless delays, realities that have compounded over time and now seriously threaten Western civilization.
My hope is the modern equivalent embodies the polar opposite set of characteristics. New era defense companies must operate with integrity and steer clear of regulatory capture if they are to power our sustainable defense apparatus. These companies must consistently deliver superior capabilities on time and under budget.
Moreover, we mustn’t be distracted by the lure of plausible science fiction. Americans must realize we’re still in the early innings of this paradigm shift and there remain many more reasons for defense startups to fail than to succeed. Investors and founders must embrace this challenge; nothing is guaranteed. This isn’t supposed to be easy.
Jake Chapman, managing director, Marque Ventures
What is your investment thesis for defense tech?
Defense is counter-cyclical, which means every diversified portfolio should have an allocation to defense in order to de-risk the portfolio overall; this is not the case today. Defense has been eschewed by ESG investors historically, but I think the events of the last couple years will convince allocators that national security is in fact part of their ESG thesis. Ultimately, this should mean our investments will see the growth-stage market ease for their fundraising.
U.S. global security commitments aren’t going down and in fact are likely to increase in our highly polarized world. While commitments keep increasing, our national finances can’t sustain those commitments if we continue working through the cost structures of the traditional primes. Thus, the United States has no choice but to shift DoD budgets away from incumbents and toward startups. This equals a historic, generational shift of capital/wealth to our market.
That is the hard-nosed financial take but at least as important for our team is that we all care deeply about the mission. I grew up in the ’80s and ’90s. America was on top, we had a balanced budget, democracy was on a roll and Francis Fukuyama had just written “The End of History.” That isn’t the world my daughter is growing up in, but if I do my job right, I might be able to deliver it to her as an adult and for her kids.
It was long assumed that defense tech was not a suitable area for venture investing because it could never achieve the returns in timeframes limited partners are looking for. Why was that the case, and how different is the landscape now compared to five years ago?
In times of relative stability, the defense industry consolidates, and regulatory capture plus lack of urgency make it hard for new entrants to compete. In times of crises, there are expanding budgets and intense political pressure for diversifying the defense industrial base. This frees up the space, the will and the capital for new entrants to be successful.
Related, we’re also seeing a fundamental change to the exit market in defense. Traditionally it was IPO or bust because M&A exits haven’t been attractive in defense. The big primes are the most obvious acquirers, but they tend to be valued at 1x to 2x revenue by the market. This makes them extremely averse to acquiring startups for much beyond that range. Compare that to an 8x to 15x exit for a SaaS company and defense looks less interesting. The new defense unicorns, though, are becoming acquisitive themselves and are willing to pay traditional tech multiples for great technology and fast-growing opportunities. We believe this means we’ll have a good and getting better exit market for technologies that don’t reach IPO escape velocity.
As more generalist VCs enter the space, what effect will this have on the defense tech ecosystem? In what way is the increase in generalist VCs making you retool your investment strategy?
Valuations are up for all the “hot” defense deals, and it’s going to be hard (though not impossible) for the companies to grow into those valuations, particularly if defense stops being a flavor of the month. When we took over Army Venture Capital, there were maybe fiveish firms who did defense or dual use. At my last count it was over 100.
I worry that the vast majority of the new entrants are investing in and diligencing defense companies like any other tech company and that they are going to get badly burned. Real success in the defense market is more than a handful of grants, a contract and verbal interest. If an investor isn’t spending time on Capitol Hill, talking with warfighters, and interfacing with the real DoD buyers, they’re just throwing darts. I think two to three years from now, we’ll be back down to 20ish firms doing defense, and some of the frothiness will be gone.
National security means more than munitions. What are the most overlooked or undervalued defense tech segments, or ones most primed for growth, in the next 12 months? Conversely, are there any areas that are oversaturated?
Oversaturated? For sure. We don’t really need any more small unmanned aerial systems (sUAS), but there are plenty of interesting areas, including contested communications (both high and low bandwidth); positioning; navigation and timing technologies in GPS denied environments; advanced manufacturing techniques suited to edge manufacturing or to dramatically ramp up domestic production; directed energy technologies; and contested logistics. There are also tons of opportunities in things that dual-use VCs won’t touch (think things that go “boom”).
As an aside, I think dual use only is a huge mistake. If you want to do defense, do defense. Dual-use-only investors will miss the defense-first deep technologies that the Valley was built on. Besides, the idea that there is virtue in not investing in things that go “boom” ignores both the need for force to defend global freedom/deter conflict and the role of technology throughout the rest of the kill chain.
What role should nondilutive financing programs play as a company builds its cap table?
Take all the nondilutive financing you can get so long as (1) the grant is perfectly aligned with your roadmap, and (2) you have the current bandwidth to do the grant work without pulling people off of something else. Basically SBIRs are great if they fund what you’re doing anyway but bad if you let them distract your business.
The underappreciated aspect of a SBIR is that winning one is deemed a “competition” under the federal acquisition regulations, which means that once you win an SBIR, a government customer can contract with you without running another open competition. This is worth more than the capital, but only if you know that the SBIR doesn’t come with a government customer and that you have to do all the government capture work yourself.
The “valley of death” is a well-known risk for commercial companies selling to the government. How can startups bridge this gap before the dollars dry up?
Working with the DoD is like solving a combination lock. All the tumblers have to be aligned at the right moment in time but when they are, everything moves. What are the tumblers?
- Warfighter interest/need.
- An official requirements documents process.
- Congressional authorization and appropriations to the right budget line items.
- Alignment with a contract vehicle.
- Alignment with the “current thing” (China or Ukraine and not the global war on terror).
Each of these is a process that moves at its own speed, but none except for the last move quickly. Avoiding the valley of death is working on all of these from day zero so that when you are ready to start selling to the DoD at scale, they are ready to meet you with a program of record.
Will venture help build the next U.S. prime? Will it look differently than today’s primes?
The past 24 months have been a challenging economic environment, but rising geopolitical tensions have been something of a counter-boon for defense tech. Is defense tech due for a reset?
Venture will build the next set of defense primes in both senses: companies that win direct major contracts with the DoD and companies that serve as integrators. Best guess is that they look much more nimble and largely avoid cost plus contracting in order to build more capability, at lower cost but higher margins for government customers. The great reset is already here; the impact might not be felt for a few more years, but we’re in the middle of it already.
David Ulevitch, general partner, a16z
What is your investment thesis for defense tech?
Demand for advanced defense technologies is at an all-time high, and today’s defense primes have demonstrated they cannot keep up with the speed of defense innovation needed to win. The fight of the future has changed how we show up to battle, and in many ways the U.S. is lagging behind our adversaries, particularly China, Iran and Russia. We believe that modern defense startups, with their ingenuity, agility and ability to attract top tech talent, are very likely to shorten and overcome the gap between what is technologically possible and what is deployed.
The “valley of death” is a well-known risk for commercial companies selling to the government. How can startups bridge this gap before the dollars dry up?
Startups building in the defense space need to have a strong understanding of the DoD funding structure and patterns, as well as who the key advocates and decision-makers in the government are. Developing an understanding of the available contracts and the system in place to obtain them will help companies avoid getting stuck in the often discussed “valley of death.”
We generally look for companies with a clear path to significant contracts, which can come in a few different ways. Increasingly, there are options to get nondilutive funding from the government, which can help extend runways, though it’s not always enough to get over the full valley. In some cases, it may make sense for companies to sell their tech to commercial enterprises as well, though we wouldn’t generally suggest this for early-stage companies that want to focus their GTM to a defense customer.
On the DoD front, we see the DoD award real contracts faster to companies that can build and deliver critical capabilities for our country, and we do work in Washington to make sure decision-makers are aware of the technologies available to them.
Will venture help build the next U.S. prime? Will it look differently than today’s primes? The past 24 months have been a challenging economic environment, but rising geopolitical tensions have been something of a counter-boon for defense tech. Is defense tech due for a reset?
Venture is financing the creation of the next U.S. primes, and beyond that, financing an entire ecosystem of suppliers, manufacturers and related companies to help rebuild and fortify the arsenal of democracy.
The leading defense companies of tomorrow will be recognized by their short time from development to market, lower cost of development, and superior ability to rapidly reorganize around new mission demands. The rising geopolitical tensions may create short-term tailwinds, but the reality is that democracy always demands a sword.
Raj Shah, managing partner, Shield Capital
What is your investment thesis for defense tech?
Shield Capital invests in founders building technologies and products with both commercial and national security uses. We believe early-stage companies focused in AI, cyber, space and autonomy can naturally serve multiple markets, including defense.
It was long assumed that defense tech was not a suitable area for venture investing because it could never achieve the returns in timeframes limited partners are looking for. Why was that the case, and how different is the landscape now compared to five years ago?
When I started my first company over a decade ago, we knew the technology that we were building would have been valuable to the government. We all had security clearances, but it was so difficult to sell to the government that our investors at the time advised us not to focus on other customers.
A decade later, this has totally transformed. U.S. and allied governments are embracing younger startups. Venture firms are investing billions into companies focused on government and defense applications. There’s no better time to found a company that serves both national security and commercial applications.
As more generalist VCs enter the space, what effect will this have on the defense tech ecosystem? In what way is the increase in generalist VCs making you retool your investment strategy?
Today, while there may be few specialist firms focused at the intersection of national security and commercial tech, you see a lot more venture firms with one partner who has this expertise and understanding of the national security market. And in fact, we have co-led deals with several of them, including a16z and Founders Fund.
Running a startup is one of the hardest things an entrepreneur can do as they are always the underdog, looking for funding, etc. Companies need to make sure that if they want to enter the national security market, they do so with a venture partner who is fluent in government, including acquisition cycles, deciphering operational needs and challenges.
National security means more than munitions. What are the most overlooked or undervalued defense tech segments, or ones most primed for growth, in the next 12 months? Conversely, are there any areas that are oversaturated?
Eleven of the 14 emerging technologies that the DoD is interested in are all being led by commercial industry. These include AI, cyber, energy, space, bio and autonomy.
I think unsexy areas of manufacturing — supply chain and logistics — offer a great opportunity for disruption and new companies and new approaches to be developed. These are very large markets that have not benefited from full modernization and will be vital for true national security.
What role should nondilutive financing programs play as a company builds its cap table?
Access to capital is critical for all startups but particularly ones with long sales cycles or capital-intensive hardware development. Equity, debt and government grants (nondilutive capital) all have a role to play.
Such grants are key mechanisms for government customers to support development of advanced technologies and to attract private investors to support companies in areas important to national security use cases. However, savvy investors recognize which forms of grants are more likely to lead to production revenue over others. Thus it is important for government grant makers to credibly demonstrate that their grants have a real ability to transform into long-term, sustainable revenue.
The “valley of death” is a well-known risk for commercial companies selling to the government. How can startups bridge this gap before the dollars dry up?
From the startup perspective, companies can be judicious as to which customers they engage with. Does that agency have the history, authority and culture to work on startup timelines? Additionally, companies that have real commercial revenue opportunities can use those markets to continue to scale as government timelines are naturally longer.
From the government perspective, budgeting reform to include passing appropriation budgets on time and avoiding continuing resolutions is most important.
Will venture help build the next U.S. prime? Will it look differently than today’s primes?
The past 24 months have been a challenging economic environment, but rising geopolitical tensions have been something of a counter-boon for defense tech. Is defense tech due for a reset?
Our current system actually works pretty well to buy an aircraft carrier that we’re going to keep for 50 years. It is not well-designed for software type systems or low-cost hardware that are continually being upgraded. Thus, I believe there is significant opportunity for new entrants focused technologies such as artificial intelligence and cybersecurity.
As the world becomes an unfortunately more dangerous place, deterring and prevailing conflict is an increasingly important priority and thus resources will continue to flow. There are a host of great companies that are delivering great value to both the government customer and their investors.
This is important for a host of reasons. First, it helps other venture investors understand that there are real economics in national security. The demonstration of strong financial returns will attract more capital and more great entrepreneurs and engineers.
We are also now seeing the flywheel effect: Many of these companies have matured, and early employees who love the early stage of startups are now leaving and starting their own businesses.
This is similar to the historical ecosystem of growth in enterprise software and semiconductors. We are still in the early innings of what is possible in national security technology, and there are incredible opportunities available for mission-focused founders.
Josh Manchester, founder and general partner, Champion Hill Ventures
It was long assumed that defense tech was not a suitable area for venture investing because it could never achieve the returns in timeframes limited partners are looking for. Why was that the case, and how different is the landscape now compared to five years ago?
We are in a generational competition with China for global dominance, and we are at risk of losing. The competition is economic, technological, social and political in nature. This is a 40-year problem. Our way of life is dependent on trade and technical flows through East Asia. The DoD recognizes the nature of the threat and the technological aspects of the military competition and is moving very rapidly to adopt new technical platforms, new tech-enabled strategies, and new operational concepts based on new technology. Venture-backed companies can play critical roles in new military tech stacks.
As more generalist VCs enter the space, what effect will this have on the defense tech ecosystem? In what way is the increase in generalist VCs making you retool your investment strategy?
Defense investing is the ultimate form of mission investing. Defense investors from decades ago are the reason why this article isn’t being written in Russian. It’s a great thing that the category has new entrants. No longer will an entire generation of American engineering graduates be slotted into adclick optimization as the best of all possible worlds for a career path.
The “valley of death” is a well-known risk for commercial companies selling to the government. How can startups bridge this gap before the dollars dry up?
We believe this is a myth in many cases. Many companies are simply not building things the government wants, or doesn’t want badly enough. If you have some sense of what the existing capabilities are, what acute pain points are, and what is on the government’s roadmap, then you are already massively de-risked.
A company building something that might be interesting to the government is going to have to convince the government it’s important and needs to be on the roadmap. A company that is building something that solves an extremely acute pain point will get attention whether it is on the roadmap or not. Having said all that, of course the government could be more efficient. But as a founder, you must assume that inefficiency, plan for it, and drive toward dominance regardless.
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