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The government wants to make quality investments in research and development, and the venture capital industry can help.
Unfortunately, the current law limits their ability to help because VC investment isn’t allowed to be an award criterion for Small Business Innovation Research (SBIR) contracts.
Yet VC investment is a signal that an investor or firm views commercial potential in a business. It’s also an indicator that a startup has a certain level of financial backing, which may be useful as the company looks to weather the notorious Department of Defense’s “Valley of Death“—a metaphor for the tendency for companies to die because they run out of money waiting for a DOD contract to be awarded.
There is typically a lengthy delay between early stage R&D awards and long-term DOD contracts. That makes defense an especially challenging market for high-growth technology startups, which tend to be cash flow negative in their early years.
Given the challenges of moving a research idea into the real world, wouldn’t the government benefit from considering a company’s venture backing as they decide which small business investments could turn into scalable technology companies for national security purposes?
How VC and Procurement Intersect
My company Learn to Win recently applied for an SBIR contract. The irony we found when completing our application was how much of it focused on explaining the “commercialization potential” of our product. There was a long list of prompts asking questions such as “How much revenue do you expect to generate in five years?” and “Does the company possess marketing expertise?”
These questions themselves were not bad per se. In fact, many were the same ones I’ve been asked dozens of times in commercial pitch meetings and in due diligence discussions as various firms were choosing to invest in my company.
More than one-third of our 15-page white paper for the government was devoted to our commercialization case.
As I was writing out each answer, I couldn’t help but think these prompts were only scratching the surface of what makes for a high-potential commercial venture. The questions were only a tiny fraction of the due diligence and evaluation that an institutional venture investor would engage in before committing to a startup.
I also wondered whether the government reviewer—reading a white paper, without an opportunity to ask follow-up questions or conduct a due diligence call—would be well equipped to make a good decision on our potential.
How VC Does It
This isn’t an area where DOD needs to reinvent the wheel.
There are people who do this commercialization potential evaluation for a living. They are called venture capitalists. They are by no means perfect, but the good ones are actually incredibly good at picking high potential ventures. According to research at Stanford University’s Venture Capital Initiative, the top 10% of venture investors create close to 90% of the overall economic Venture Capital value. Funds like Sequoia Capital often generate close to 1,000% returns, dramatically outperforming the market, according to analysts.
These are really smart people who spend all day, every day, often for decades, evaluating and making bets on the commercial technologies with the most market potential. The good ones get really, really good at it.
It’s super hard to do well. According to an analysis at Stanford University, the average venture capital funds don’t outperform the market, and many actually lose money.
A Trusted VC Network?
The US Government would be well served if the VC opinion could be incorporated into their own thinking on the commercial potential of ventures. They could even outsource most of that evaluation of commercial potential to the folks who do it best, the venture investors with a track record of selecting winners.
Just as the Pentagon has established the Trusted Capital Network to attempt to secure the industrial base from adversary foreign investment, so too the DOD should establish relationships with the most successful investors as a pipeline for promising defense startups and incorporate their perspectives into their own evaluation processes.
If the SBIR program truly wants to be “America’s Seed Fund,” it should least be able to incorporate the opinions of the people who do this challenging task for a living.
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Andrew Powell is the co-founder and CEO of Learn to Win , a learning technology company serving pro sports teams, the US Department of Defense, and Fortune 500 companies. Andrew holds an MBA from Stanford University’s Graduate School of Business, where he helped launch a new course called Technology, Innovation and Modern Warfare, as well as a BA from the University of North Carolina at Chapel Hill, where he was a Morehead-Cain Scholar and the student body president.
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