Venture activity in the government landscape is about market share

If it looks like venture capital is increasingly eying at the government market landscape including defense as a place to be, then these statistics might confirm that the answer is "yes."

The amount of investment capital having gone into venture-backed defense technology startups has doubled to $33 billion in 2022 from the $16 billion fetched in 2019, according to a presentation given Wednesday at the Professional Services Council's annual Vision Conference for industry and government executives.

Artificial intelligence, autonomy and space are among the technology areas highlighted by session presenter Jen Chaquette as of keen interest to investors looking at early-stage companies that show promise.

Venture investors are high-risk and high-reward for the most part. They bet on fast growth in all of their investments in young companies.

Startups can also scale rapidly once they find success, which can lead to the raises of more capital from investors who pick up on what those businesses are doing.

But as panelist Mikhail Grinberg cautioned attendees in Arlington, Virginia: "The budget isn't going to deliver the kind of growth" this group of investors typically wants to see in portfolio companies.

Which means that in the defense and government market, investors focus instead on emerging and more commercially-minded businesses that are perceived as being able to take market share away from others.

Companies in category one often have several billions of dollars in capital from their investors to work with.

Grinberg identified the longer-standing, traditional government market players as those in the other category.

Or as he also characterized the group of those companies being chased: "Much of it is sitting in this room and rooms like 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 industrial base structure, that it is ripe for disruption," Grinberg added.

Commercial disruption across the entire public sector landscape may have been an inevitability when looking in retrospect. Fellow panelist Frank Finelli said that in 1989, at least half of all scientific funding in the U.S. came from the federal government.

Fast forward to today and that share drops below 20%, Finelli said, adding that means the government has to lean on the technology development activity taking place across the broader commercial ecosystem.

Contractors whose executives were in the room at Vision then have to adapt that technology into 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 fulfill their commitments to investors.

They also have to be at a certain scale and critical mass of financial and human capital resources to be able to fulfill the requirements of their current and potential government customers, plus for developing and scaling the technology.

"That costs a lot of money, and so they burn through the cash that they've gotten from investors, and at some point they need to go back to the markets," Finelli said. "The problem is, that in these markets today, there are few approaches to get that cash."

Venture credit is non-existent because of the failures of Silicon Valley Bank and other plugged-in financial institutions like SVB, initial public offering volume remains low, and going back to the existing investor base often means presenting a rescoped plan for the business.

But one venture investor stands alone as the "single, greatest" in the government space as Anita Antenucci pointed out: urgent operational needs that are stated and funded by the U.S. government.

"Nothing can replace that, and that is what in effect, the investors are chasing," Antenucci said. "They are taking a bigger bet than most have been willing to take in the past, that they understand what that need is."

She presented two scenarios for attendees to consider. One is that if venture investors are right and willing to finance independent research-and-development or other similar concepts against that need, then the economics change for a U.S. government that can wait to commit more funding later on.

But a potential miscalculation of investors would mean they did not correctly model the revenue coming in from government programs, she said.

"This is one of the reasons venture capital has been so minimally available to defense and government companies for so long," Antenucci said.

A more conservative approach to venture investing in the space seems the most likely scenario at this juncture, according to Antenucci.

"You're going to see savvy investors in the space stick to a little less aggressive bets on the sector because they know things materialize a little more slowly."