SIMI VALLEY, Calif. — Venture capital firms are often cautious when investing in companies that are looking to get into the defense space, given the potential long-waits for a return on investments.
One potential option for companies in the defense sphere that need an influx of cash but can’t get a VC to bite? Looking to an array of corporate-backed venture funds from the largest prime contractors.
Those firms aren’t direct competition for the traditional VC players who want to “lead” a deal, according to John Tenet of 8VC, who participated in a Defense News roundtable in California about the Pentagon’s efforts to work more effectively with the tech community. Tenet also points to the relatively small dollar values of those corporate-backed funds. Lockheed Martin Ventures, for example, has invested only $190 million since 2007. Boeing’s equivalent has made 25 investments, all less than $10 million, since forming in early 2017.
And there is a level of distrust for corporate-backed funds from the defense industry, with Trae Stephens of Founders Fund describing them as a white-washing attempt to hide the strong grip those firms have on the defense sector.
“When you’re a monopoly, you spend all of your time trying to convince people you’re not a monopoly. A corporate venture fund for the defense oligopoly is trying to convince people that there are other players that are relevant to the market,” Stephens said.
The appeal for companies themselves is also in question. Daniela Perdomo, founder of goTenna, and Ryan Tseng, founder of Shield AI, both have had talks with defense firm-backed venture funds but ultimately never went down that road. According to Tseng, there is a “strong preference” among leaders of tech firms for “pure-play investment firms” as opposed to defense primes.
“The deals are less complicated. The incentives are more strongly aligned. I think that strategic investment funds, the ones associated with the business whether a prime or major tech companies, they're a little bit different flavor,” Tseng said.
Said Perdomo, “I talked to them. I did not take any money from any of them. It didn’t seem clear that there would be any value add. It was sold as this will allow us to partner on integrations or projects, but I didn’t understand why taking money from them would make [teaming up] more likely than if I didn’t take money.”
Essentially, she said, if the primes want her technologies badly enough they are willing to invest through a venture fund, they’ll need to partner with goTenna anyway.
So how do the corporate-backed firms fit into the broader VC sector? There’s two approaches they tend to bring, according to Brian Schettler, managing director of Boeing’s HorizonX venture, who acknowledged that the broader VC sector often has reason to complain about corporate-backed venture efforts, in particular due to efforts to lock up exquisite technologies.
Investments from corporate funds, whether in the defense world or not, often come with “some form of onerous terms and conditions in the language of the investments, the deal docs, or some other commercial arrangement that is trying to protect exclusivity or future options to buy the whole thing outright,” he told Defense News in January.
The other tactic, one taken by HorizonX when it was stood up in early 2017, is to serve as seed money for a range of technologies that could have positive impact on the aerospace and defense sector, while allowing those firms “as much decision space as possible” to sell to the entirety of a potential market, Schettler said – without trying to lock up exclusivity early.
If the defense sector, in particular, is “viewed as an unattractive market, where these corporates are just going to swoop in and either gobble me up early before I reach our full potential or just come with all of these terms that suck the life out of them for the enjoyment of being that entrepreneur, that’s not the ecosystem we want to promote,” Schettler said.
Like Schettler, Chris Moran, general manager of Lockheed Martin Ventures, said part of the reason defense primes are investing through venture capital is to tap into technologies that are being developed at a rapid pace
“We realized, in house, that the VC industry is basically replacing some of the R&D around the world,” Moran said, noting there will be over $400 billion in VC investments worldwide this year, most of which is in R&D spending. “A vast amount of new developments are happening outside the four walls of the prime contractors of the world. We need to participate in those areas and keep pace to at least understand what’s going on, and hopefully to benefit from it by making these investments.”
When weighing whether to try and acquire a company after connecting through the VC arm, Moran said the decision often lies on whether a firm can work within Lockheed’s almost exclusively-defense oriented portfolio.
“Mostly what we’re looking for when we acquire are companies that could either become good suppliers of a technology we’d love to buy down the road. We’re not going to buy a business that’s 50 percent, or more, commercial. It just doesn’t fit what we want to do. What we’re trying to do is be that partner, ultimately, be that supplier, be a market for them," he said, noting the size of Lockheed’s global staff that can be brought in to help out a young company.
And like his counterpart at Boeing, Moran made it clear he doesn’t take any negative comments from the non-corporate venture community personally, seeing it instead as a little but of a culture clash and a little bit of corporate gamesmanship.
“Realistically, 80% of start-up companies that become successful end up being acquired by corporate investors. Ultimately what it comes down to is, financial investors who seek a large exit don’t want the potential acquirers sitting around the table early. They believe they get better value that way,” Moran said.
“I’ve been doing this for 15 years as a corporate venture capitalist. Take off Lockheed or Boeing’s name from the fund and put in Shell, Daimler, any large company — the comments will be exactly the same,” he added. “There is a little competition between corporate and institutional investors for deals. So, there is a little bit of elbowing that goes on. It’s just the corporate-versus-institutional- investor gentle jostling.”
Aaron Mehta was deputy editor and senior Pentagon correspondent for Defense News, covering policy, strategy and acquisition at the highest levels of the Defense Department and its international partners.