Defense Technology

AIN Ventures Series:

Defense Technology

June 2022

By Emily McMahan, Chase Contreras, Zachary Horowitz, Bryan Holst, Maxwell Bulba

Introduction

Russia’s February invasion of Ukraine was a stark warning to the rest of the world that despite relative economic and diplomatic stability, belligerent state actors can and will act unilaterally without regard for the court of public opinion or possible long-term diplomatic, economic, or military consequences. In addition, the ramifications of this war are further amplified in the face of America’s ongoing great power competition with China. While the competition itself does not necessarily lead to conflict, recent events have brought us front and center to the reality that maintaining a technological edge and being prepared is crucial in a dynamic geopolitical environment. At Academy Investor Network (AIN) Ventures, a fund founded and led by military veterans; these themes have influenced the majority of our careers and lives. One of our primary activities is to invest in companies at the intersection of dual-use technology and deep technology. These innovative companies develop technologies that can apply to the government and commercial sectors. We believe that investing in deep technology makes our country safer, more efficient, and more competitive in well-established and emerging industries.

With regard to investing at the intersection of deep tech and dual-use, AIN Ventures invests in defense, space, civic, healthcare, sustainability, and disaster technology. AIN is publishing a series of articles on these verticals, and this article represents our views on Defense Technology. (Please see our recently published paper on space technology).

What is Defense Technology, and Where Did It Start?

Defense technology is the intersection of commercial innovation and national security. The origins of this industry date back to World War II and Fred Terman, a “father of Silicon Valley.” During World War II, Terman and his colleagues at the then-classified Harvard Radio Research Lab fought on the front lines of Electronic Warfare. They developed breakthrough methods that were crucial in countering the German air defense system. After the war, Terman and a few team members established another research lab at Stanford University. As pressure from the Cold War put the need for technological progress into sharp focus, the Department of Defense (DoD) began heavily funding university-led research at Stanford and other colleges throughout the country. Terman and his team made tremendous progress. By 1950, according to Steve Blank’s Secret History of Silicon Valley, Stanford developed expertise in “electronic countermeasures, electronic intelligence, and signal intelligence,” and its primary customers were “the National Security Agency (NSA), the Central Intelligence Agency (CIA), and the arms of the military.”

As the Cold War continued, the U.S. government maintained its partnership with Stanford. As the university's Provost, Terman founded Stanford Research Park and spearheaded a shift in an academic culture that encouraged graduate students to start companies rather than pursue PhDs. This combination of federal funding and pioneering leadership created a place where established businesses and entrepreneurs could partner with the government to deliver new, advanced products and systems. With this in mind, it is not surprising that companies like Lockheed Martin and General Electric thrived in the same place that simultaneously gave rise to Hewlett-Packard and Intel. In short, the defense tech industry emerged alongside Silicon Valley and remained a crucial area for innovation and entrepreneurship.

Understanding the history of this space makes it possible to see its importance to the defense industry and the nation overall. In 1983, President Reagan said, “The defense policy of the United States is based on a simple premise: The United States does not start fights. We will never be an aggressor. We maintain our strength in order to deter and defend against aggression -- to preserve freedom and peace." Defense tech, therefore, reaches far beyond the technology itself and into our nation’s policies, operations, and doctrine. It influences how we fight our wars, affects economies worldwide, and impacts the balance of power internationally. As the U.S. government continues to push the speed at which the military adopts these technologies, investment into new, revolutionary ideas and founders will be more critical than ever to maintain our nation’s competitive edge.

What are Examples of Defense Tech?

Defense tech is any service or product that can be employed to defend national interests, including personnel, equipment, or systems. For example, this year’s 61st National Defense Authorization Act (NDAA) states that our most critical defense priorities include: hypersonic weapons, artificial intelligence, 5G, and quantum computing. Other focus areas are biotechnology, microelectronics, machine learning, and autonomy. These technologies are represented in all warfare domains - sea, air, land, space, and information.

Why is Defense Tech Important?

The course description for Stanford University’s “Technology, Innovation, and Great Power Competition'' may be the best summary of why defense tech matters today. The course, taught by Steve Blank, Raj Shah, and Joe Felter, states, “For the first time since the start of the Cold War, Americans are being confronted with the prospect of being unable to prevail in a future conflict. . . In 2017, the Chairman of the Joint Chiefs of Staff, General Joseph Dunford, warned that ‘In just a few years, if we do not change the trajectory, we will lose our qualitative and quantitative competitive advantage. ’Those few years have passed, and this dire warning is arguably coming to fruition. . . Competing effectively in the modern international system and regaining America’s competitive edge will require not only the rapid adoption of advanced technologies but more significantly by the degree and speed in which these new technologies are leveraged to operate in the new ways required to survive and prevail in the 21st-century threat environment.”

From the perspective offered above, it is clear that the creation and adoption of defense tech are crucial for the United States to maintain its global position in great power competition, especially in light of Russia and China’s recent commitment to one another.

How Much is Spent Each Year on Defense?

The FY22 NDAA supports $777.7 billion in funding for national defense (up from $740B in FY21 and $738B in FY2020). In FY20, the federal government obligated $665 billion (an unprecedented year due to COVID), with the DoD awarding $421 billion in contract spending. For context, the entire venture capital industry invested $329.9 billion in a record 171,054 deals in 2021.

What About Recent Legislation?

The Infrastructure Investment and Jobs Act of November 2021 allocated $550 billion over five years for transportation, water, power, broadband, and resilience infrastructure. In addition, this law spurs spending for many emerging technologies and research across the government and many sectors in need of modernization, such as carbon capture and small, modular reactors.

In June 2021, the United States Innovation and Competition Act of 2021 (USICA) authorized basic and advanced technology research over a five-year period. As a result, investment in basic and cutting-edge research, commercialization, education, and training programs in artificial intelligence, semiconductors, quantum computing, advanced communications, biotechnology, and advanced energy amounts to $100 billion.

The Challenges Between Defense, Startups, and VC

Companies that can solve critical problems for the DoD have the best opportunity to take advantage of government funding and follow-on contracts. However, there can often be gaps as the company goes from a research and development phase to a contract award (see AIN’s paper on The Valley of Death) pursuing scale and revenue.

According to the Silicon Valley Defense Group (SVDG), a significant challenge for venture-backed companies attempting to do business with the DoD is that while they are “under constant pressure to achieve scale, [they are also] potentially ignoring [the] Defense industry as a customer.” The SVDG states that companies are “unsure of where to start and who can help'' and that “it is difficult for venture-scale firms to consider entering the defense market as their technology matures.” This dilemma between scaling rapidly and contracting with the government results in many startups ignoring a potential long-term federal customer base.

Are There Any Solutions to These Challenges?

One solution blazing a potentially successful path amongst the services is led by the U.S. Department of the Air Force. Its Strategic Funding Increase and Tactical Funding Increase Program (STRATFI / TACFI) helps transition businesses of various sizes into accessible defense tech companies that deliver “strategic capabilities” to the Air and Space Forces. Working with the Department of the Air Force Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs, AF Ventures launched a transition-focused funding opportunity for the U.S. Air Force and U.S. Space Force startups and companies. In the coming weeks, AIN will be releasing a mid-year analysis on the performance of firms awarded TACFI/STRATFI funding against their peers in the dual-use tech space.

The STRATFI, or Strategic Funding Increase, focuses on large-scale, strategic capabilities, and TACFI, or Tactical Funding Increase, focuses on transitioning smaller-scale tactical capabilities. This government-led, co-private investment technology development model requires investments from at least two sources of capital; one from an Air Force SBIR/STTR and the other from a public or private capital source.

STRATFI offers small businesses between $3 million and $15 million in SBIR funds over four years. Because of the requirements and strategic nature of the program, participating companies can choose from multiple matching funding pathways from the government or private sector. In addition, the matching funding criterion enables the government to gain a no-nonsense view from the private sector regarding the commercial and financial return viability of a company.

Similarly, through TACFI, startups can receive from $375,000 to $1.7 million in SBIR/STTR funds over two years. And for every dollar of SBIR/STTR funds, these companies must also receive at least $1 of other government funding (i.e., non-SBIR/STTR) or $1 of private funding.

Are There Any Successful Defense Tech Venture-Backed Technology Startups?

One of the most well-known defense tech venture-backed companies is Anduril Industries, a Los Angeles-based defense tech company that connects autonomous sensemaking and command & control capabilities with open, modular, and scalable hardware components for a layered family of systems approach. The company achieved unicorn status in just four years - raising $700M with a $5B valuation. Also of note, Anduril moved from a pilot program to a Program of Record in less than three years — the fastest transition of a program in the national security space in seven decades.

Some other relevant defense tech VC-backed companies are Shield AI, Rebellion Defense, Palantir, Improbable, Scale, Joby Aviation, Percipient.AI, C3.ai, and Vannevar Labs.

Who are the Key Defense Tech VC Funds?

General Catalyst, Lux Capital, and Founders Fund are some of the established and most well-known funds actively investing in defense tech. In addition, more and more funds are establishing defense-related areas to strengthen ties between government and tech in Silicon Valley.

In addition, there are also corporate-backed venture funds from some of the largest defense prime contractors like Lockheed Martin Ventures and HorizonX (which is affiliated with Boeing) that often invest in technologies to help them keep pace with the level of research and development happening in early-stage companies.

What are Some of the Most Relevant Government Organizations in Defense Tech?

Today, a few very impactful organizations work hand-in-hand with industry to drive innovative solutions to solve the U.S. Government’s current and future problem sets concerning national security. Some of these critical organizations include the Defense Innovation Unit (DIU), In-Q-Tel, DARPA, and AFWERX.

Why Does Defense Tech Matter to AIN Ventures?

As an institutional investor built by military veterans, AIN Ventures intends to leverage its unique network to invest in defense technology. In addition, we will leverage our experiences as investors, founders, builders, and military veterans to help companies navigate government and commercial timelines in the most optimal way possible.

We create and connect groups of former military officers with specific domain expertise across our main focus areas and defense tech. Because of our understanding of government and commercial markets, these groups help source, diligence, and provide post-investment support to companies. Additionally, we leverage our extensive networks of government and commercial leaders to help accelerate the adoption of commercially viable innovations. At AIN Ventures, we are commercial-first dual-use technology investors. This means that we realize the SBIR/STTR programs and the path to becoming a program of record still has tremendous challenges. That requires companies to simultaneously pursue commercial customers of some kind so that they do not fall into the “Valley of Death.” At AIN, we fully understand this potential trap and help our companies navigate it.

AIN Ventures recognizes defense tech’s critical role in maintaining the integrity of our national security infrastructure. Therefore, firms like AIN Ventures must catalyze defense technologies crucial to national defense. If you are looking to raise venture capital, please reach out to us at deals@academyinvestor.com or apply through our portal. Additionally, you can follow us via this AIN Newsletter Signup Link.