The US Government’s Innovation Valley of Death
An outsiders’ guide to building success in government innovation
By Richard Tippitt and Sherman Williams
Disclaimer: This paper defines the Valley of Death, why it exists, and what can be done to mitigate this risk externally from the government. For accelerated innovation across the government to take place, endemic acquisitions issues must be addressed. This paper does not cover those topics.
1. What is the Valley of Death?
Throughout the Cold War, from atomic energy to ARPANET, the US federal government was the worldwide leader in developing cutting-edge technology. Most advancements in commercial technology originated in federal labs up until the late 1970s. However, since the dawn of the digital age, private investment in technology has outpaced the government, and it now dwarfs federal R&D spending. Moreover, these investments from commercial markets tend to focus on short-term gains over long-term investments. As a result, the government continues to use outdated, specialized technologies built by monopolistic prime contractors because these unique problems lack adequate funding for continued innovation. To address this gap, the federal government has redirected funding towards the earliest stages of promising innovations that have the potential to solve our country’s toughest challenges. Unfortunately, this refocus on early-stage companies has created an unintended “valley of death” between i) early non-dilutive funding from government innovation organizations and ii) production-level government contracts as a program of record.
Source: GAO-21-202
2. Why does it exist?
The commercial and federal markets move at different speeds due to distinct differences in their motivations and needs. The US federal government, led by the U.S. Air Force, repurposed the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs to address these differences. Still, they fail to deliver the repeatable success metrics (such as Annual Recurring Revenue/Monthly Recurring Revenue) necessary for companies to raise venture-type funding. Unfortunately, the traditional government acquisitions process, and even many innovative bypasses to the federal acquisitions regulation (FAR), fail to move at the speed necessary to prove a product’s viability before many companies need to raise capital. This process hurts startups in two ways. First, they cannot raise enough non-dilutive funding to sustain operations, especially if building bespoke iterations of their commercial product for government customers. Second, their focus on the government hinders their ability to show traction and subsequently attract commercial funding. On top of this issue, government-based funding authorities do not examine startups through the same lens as private investors, so unfamiliarity with the government process leads to misunderstanding non-dilutive funding as product-market fit. It is, most often, “product-task fit” at best. As a result, institutional investors without this understanding tend to avoid deals with companies solely or primarily focused on government customers. As a result, the ability to invest in such technology requires a patience and tenacity that most investors are uncomfortable with.
3. Why Should We Care?
In the modern, globally connected world, the United States has an outsized impact on the world via its technology exports. Due to this technological edge, American democratic values reach worldwide audiences, and authoritarian regimes want to close a gap. These countries with competing ideologies corrupt the free flow of information via technology to their advantage. They do this directly against the influence of the United States and to prevent the spread of information competing against their established, internal national narratives. Given the opportunity to gain a technological advantage, these countries would attempt to impose their values worldwide, values that are diametrically opposed to those of the U.S. and our allies. Stated another way, the United States must improve its innovation ecosystem and prevent viable technologies from falling into the “valley of death” or risk losing its status as leader of the free world. The nation’s largest, most complex problems are exacerbated by and solved through technological innovation – the deciding factor is which side succeeds first.
4. What can we do about it?
a) Startups
Any startup looking to the federal government for business needs a strategic plan to enter the market and a tactical plan to accelerate growth. Stephen Rodriguez at Defense News states that the valley of death “persists because startups fail to address the government market in a methodical way.” Many founders mistaking early R&D grants as market validation eagerly commit to building a product that has a smaller than expected market, diverting precious long-term resources from potentially lucrative commercial opportunities. Instead, startup founders should establish a systematic approach to their work with the government that focuses on finding ways to improve the commercially-viable product leveraging non-dilutive funding.
Despite the timelines, startups should not shy away from non-dilutive funding due to fear of being distracted from commercial goals. Government non-dilutive funding subsidizes the companies’ preparation to bring the company to commercial markets. Understanding this process and having patience remain critical skills for obtaining government funding because most government employees do not have the authority to make decisions. In fact, especially in the Department of Defense, Congress maintains the sole authority for most financial decisions. This centralized structure is challenging to empathize with for many modern, flat organizations, and the tendency is to react in frustration even when the customer earnestly wants to move faster.
Despite the government’s centralized approach to decision-making, startups should not treat the government as a single entity. Each department, agency, and military service has unique needs, processes, and problems. Finding the right customer does not require in-depth knowledge of the entire government, but some institutional knowledge helps with navigating the various organizations. Furthermore, knowing how to bridge a government and commercial strategy and best leverage government non-dilutive funding to further commercialization goals is essential to sustained success. Finally, hiring former government personnel (i.e., military veterans) with procurement or innovation experience can serve as a resource for understanding the regulatory environment and the broad network of potential end-users and decision-makers.
b) Investors
In the same way private investors can play a crucial role in building a startup, they can also play a pivotal role in killing one. These investors must show a fiscal return on investment to their stakeholders, as opposed to the government’s approach to funding technological advancement for their own use. A 2003 NREL study of this problem in earlier iterations of the SBIR process noted that “the availability of public sector funds decreases abruptly after the technology is created, because...the public sector views subsequent investment as the purview of the private sector.” The federal government cares only so far that the technology exists and does not intend to commercialize a product for profit. This misalignment creates frustration and misunderstanding that can lead to the failure of viable technological innovations.
Today’s large defense contractors established a near-monopoly on the government market by identifying and investing in promising technology throughout the Cold War. The same opportunity exists today for commercial investors through investing in promising early-stage technologies. However, according to the National Center for Science and Engineering, while the overall ratio of R&D expenditures to GDP in the United States grew since the mid-1990s, the government portion of that funding shrank. This downward federal funding trend resulted in fewer dollars for incubating promising technology and inventors’ scientific research within federal labs.
Therein lies an opportunity for private investors to invest in companies that can disrupt existing markets and even create new markets while knowing a potentially viable government customer for that technology exists. However, this investment strategy requires understanding the nuance of showing “product-task” fit within the government. It tends to be binary with one significant contract award or a few moderate awards instead of exponential growth. Because funding and support both ends when the SBIR/STTR award expires, investors need to adopt new ways of understanding the government’s needs and diligence potential solutions provided by startups. The long-term growth of the traditional defense contractors, despite massive downturns in federal defense spending since the end of the Cold War, proves viable their strategy of identifying and investing in federally focused technology despite a potentially longer return timeline by capturing an entire market.
5. What is AIN Doing About It?
As an institutional investor built by military veterans, AIN Ventures exists to invest in companies typically excluded from or forgotten by the traditional venture capital market. Our experiences as investors, founders, builders, and veterans help us better understand government and commercial timelines and their limitations from a financial, growth, and national security perspective.
At the Academy Investor Network, we are creating and connecting groups of former military officers with specific domain expertise across our main focus areas (space tech, sustainability tech, health tech, defense tech, cyber security, civic tech, and disaster tech). According to 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 senior government and commercial leaders to help accelerate the adoption of commercially viable innovations. We want to assist any startup operating at the intersection of dual-use and deep technology that lacks the support or funding necessary to cross the chasm into accelerated government adoption and eventual wide-scale commercial adoption. We also want to democratize access to our knowledge of crossing this chasm by openly discussing deals with any interested investors. As former chief innovation officer at the US government agency Federal Deposit Insurance Corporation (FDIC) Sultan Meghji stated in his resignation letter, “learning from our friends is essential to staying ahead of our enemies.” If you are a company looking to raise venture capital funding, please feel free to reach out to us at deals@academyinvestor.com or submit an application through our portal. Additionally, you can follow us via this AIN Newsletter Signup Link.