Defense Innovation & Venture Capital

Editor's Note:  For a case study on the success of Private-Public Partnerships, read Defense Innovation & Venture Capital: Skydio a Case Study.

I have spent my adult life leading teams in combat. I was fortunate to serve in some of the world's most elite special operations units. Throughout the last 20 years, we have always had a technical superiority however, our military technology has, at times, failed to compare to civilian technology. I constantly asked myself why we didn't have better technology to help us on our missions? Why didn't all the technology sync? Why was this acceptable? And what needs to change?

Investing in national security is the most critical impact investment - failure to do so could dramatically change the trajectory of our nation and the way of life for future generations. 

Conflict is the greatest catalyst for innovation. Even the staggering numbers of venture capital that have gone into innovative companies cannot compete. In 2021 alone, United States venture capital firms invested over $621 billion into companies. Capital is the fuel that drives technology companies to produce software products that have generated even more impressive revenue numbers. While these numbers are significant – they are no match for the innovation engine that was driven by mutually assured destruction. Every war and conflict produce technological innovation. 

World War II catapulted the United States out of the Great Depression and allowed them to harness the power of America’s industrial might and put them on a path to serve as the dominant power in the world. Due to rapid innovation to ensure tyranny and authoritarian governments did not rule Europe and Asia, the United States won the race to develop the first atomic weapon. While the destructive power of the atomic bomb was horrific, the collaborative effort between the scientific community, university researchers, industry, and the U.S. government ensured the end of WWII, and it helped pave the way for future technological developments like nuclear power. The end of WWII gave birth to a new kind of war - not one fought in trenches, beaches, or open battlefields. The beginning of the Cold War between the U.S. and the USSR stimulated incredibly impactful technological advancements. The current conflict between Russia and Ukraine is no different. It has shown rapid advances and the use of technology in a concise amount of time. 

Today, Silicon Valley is synonymous with Google, Facebook, Microsoft, and other technology companies. But Silicon Valley originated long before those companies existed. Decades ago, a remarkably close partnership between the DoD, Stanford University, and some brilliant, innovative, and patriotic engineers sparked what is now known globally as Silicon Valley.

On October 4th, 1957, the USSR launched the Sputnik satellite into low earth orbit, which is now known as the Sputnik Moment. The decades following sparked an unprecedented public-private partnership that spurred an impressive display of innovation, leading to the space race, the development of advanced weaponry, stealth, Global Positioning Systems (GPS), and countless other priceless technologies.

During the early years of Silicon Valley, venture capital didn't exist. It was challenging for budding technology companies to raise outside capital unless they could generate immediate revenue - wealthy individuals were not keen to invest in technology, at least not yet. The only feasible way for a company to get funding for its research was to tailor their research to defense products and apply for government grants. This relationship significantly strengthened the partnership between the Bay Area and DoD. With notables like Fred Terman from Stanford University’s Electrical Engineering lab and William Sockley who founded Shockley Semiconductor, the amount of engineering talent that moved to the San Francisco Bay area and by design, worked on military-related technology, quickly grew. Several pieces of legislation passed by Congress in 1958 and 1974 made it easier and more profitable for investors to invest money in companies. 

With this new form of capital influx, non-DoD companies started to emerge due to VC funding. The dot-com era further evolved the relationship, and Silicon Valley was now a household name. But few remember its public-private partnership origins. The irony is lost on the Google employees who organized a company walk-out for not wanting their tech company to be affiliated with DoD (despite Google's long history working with DoD) and the many Palo Alto residents and Stanford students who hike "the Dish", which was originally the satellite dish that collected radar signal waves that were bounced off the moon from USSR anti-aircraft radars located within the Soviet Union during the Cold War.

While the commercial sector continues to innovate and cutting-edge technology is increasingly essential in America's looming conflict with China, DoD's innovation ecosystem remains fatally inadequate and wasteful. A 2021 report identified unenticing investment size, an archaic and risk-averse DoD acquisitions ecosystem, and a systemic fear of losing intellectual property rights. Venture capital firms rarely want to invest in sole DoD-use companies as their investment return faces unacceptable speed and risk levels. Although DoD has relentlessly tested approaches to catalyze innovation, it has created a system of innovation tourism, almost exclusively focused on early-stage ventures. Additionally, Small Business Innovation Research (SBIR) grants, while non-dilutive, are not considered predictive, recurring revenue. Finally, while defense primes have their place for developing large systems, they are best suited for procuring large material solutions, not innovative technology. 

Throughout the VC industry, there is still an existing false narrative that if a company relies on sales to the U.S. Government, then it is not worth investing in. While some VCs still speak that narrative, it is beginning to change. The credit goes partially to the Defense Innovation Unit, but mainly because of Tier 1 venture capital firms such as Andreesen Horowitz and Founders Fund that have grown more interested in investing in defense technology. Part of this is also due to the success of billionaire-backed defense companies Palantir and Anduril.

With a budget of over $800 Billion, DoD does not have a capital problem; it has a capital deployment problem due to an acquisition system designed to eliminate risk. 

On the contrary, VC’s entire business model is based on risk – hence the name "risk capital." Successful investors and the firms they work for in VC are rewarded for making large, risky bets. While some companies they invest in fail or strike out, others get a base hit while only a small percentage hit a home run. What makes the model successful is that those home runs are so profitable that they can return the entire fund to the limited partners with just that one company's exit. Venture firms are measured on their home runs. As long as a fund can achieve one or two per fund, no one complains about the companies that were a risk and did not pay out. 

Moreover, incentives in the VC ecosystem are clearly aligned. The relationship between a company and an investor does not stop at the investment – it is just beginning. The best investors tend to be previous company founders and startup CEOs, as they can lean on their experience to help their portfolio company scale to success. It is in their financial interest to do so. The venture world is relatively small, and partners establish a reputation for being able to pick winners – the venture ecosystem knows not only what firm invested in a successful company, but also which partner sourced the deal and helped ensure the company's success. Investors gain a reputation for how much value they bring to a company (besides cash). The risk and reward potential allows VC to take chances on companies; a phenomenon that does not exist in the DoD.

The fund-raising cycle of a startup's life occurs roughly every 12 to 18 months. A startup needs additional investments of capital at those intervals to sustain operations and continue its growth. Most startups are not profitable - often intentionally, as the main focus is directed at R&D and growth. This is why VC funding is so essential. It helps companies bridge the 'valley of death' – the period of unavailable financial resources that would cause a company to go bankrupt. Suppose a company is solely dependent on government contracts and grants. In that case, the likelihood of dying in the valley of death is exponentially greater due to the long sales cycles of DoD and bureaucratic and slow contracting mechanisms. This is why it is essential for a defense startup to not solely rely on government grants but also blend their funding with VC investment.

The U.S. has ventured into a new era of competition with China. While this competition is not currently on an open battlefield, it rages in cyberspace and the economic and acquisition domains. China has out-prioritized the U.S. in research and development, which has led to rapid innovation. Coupled with a propensity to engage in intellectual property theft, China's technological capability in certain areas is beginning to outpace the U.S.

Now, more than any other era in history, the U.S. must rally its innovation base to maintain its edge and, in some areas, keep pace with its adversaries. While there have been attempts to stimulate innovation efforts, none have made a real impact in the race to innovate and integrate key warfighting technologies against our peer adversaries. Chinese technological innovation is advancing rapidly and may outpace the United States if it does not take drastic measures to incentivize innovation.

China has mastered coercion to achieve its objectives by combining its civilian, military, and academic elements. They have taken on a whole-of-nation approach with the goal of being the dominant world power by 2050. Some individuals and small-scale (relative to China's organization and collaboration) programs like Hacking for Defense or the Defense Investor Network have attempted to stimulate innovation. Still, they are, unfortunately, an order of magnitude less than Chinese efforts. 

DJI, the leading hobbyist drone company, is a perfect example of China's ability to bridge the public and private sectors to achieve dominance in a market. DJI benefits from a close partnership with the Chinese Communist Party (CCP) - the division between government and commercial companies in China is indistinguishable.  CCP funding has stimulated DJI as subsidized R&D spending ensured a continually innovative product. DJI's partnership with the CCP prevents many United States federal agencies from using DJI products due to the presence of Chinese tracking software in every drone.

It is critical that the United States leverage public-private partnerships to stimulate the innovation base and regain its technological edge. VC is a proven model of success that provides consistent record returns. Give the all-star players the right tools and knowledge, incentivize them to partner with DoD, and let them execute. The urgency to stimulate defense innovation to keep pace with China cannot be overstated. The CCP is playing by a different set of rules, and whether stealing intellectual property or leveraging the power of its authoritarian regime, they are out-innovating the United States. While the U.S. must hold true to its values, change must occur if the U.S. wants to continue to be the dominant power in the world. 

The Sputnik Moment has passed. It's time for the United States to act like it.

Andy Yakulis is LTC in the U.S. Army and leads a team that serves as the industry outreach to technology companies and dual-use Venture Capital firms. He is a former special operations officer with over 17 years in the Army. He was a Sloan Fellow at Stanford Graduate School of Business where he has a Master of Science in Management and holds of Master of Arts in Defense and Strategic Studies from the Naval War College. He is a national security innovation fellow at Stanford University’s Gordon Knot Center for National Security and is a startup mentor at Harvard Business School.

The views expressed in this article are the author’s own and not that of the U.S. Army, Department of Defense or Stanford University.