TechCrunch: Interview with Jake Chapman
Marque Ventures’ Managing Director, Jake Chapman, is interviewed by Aria Alamalhodaei for TechCrunch on defense tech.
What is your investment thesis for defense tech?
Defense is counter-cyclical, which means every diversified portfolio should have an allocation to defense in order to de-risk the portfolio overall, this is not the case today. Defense has been eschewed by ESG investors historically, but I think the events of the last couple years will convince allocators that national security is in fact part of their ESG thesis. Ultimately, this should mean our investments will see the growth-stage market ease for their fundraising. U.S. global security commitments aren’t going down and in fact are likely to increase in our highly polarized world. While commitments keep increasing, our national finances can’t sustain those commitments if we continue working through the cost structures of the traditional primes. Thus, the United States has no choice but to shift DoD budgets away from incumbents and towards startups. This equals a historic, generational shift of capital/wealth to our market.
That is the hard-nosed financial take but at least as important for our team is that we all care deeply about the mission. I grew up in the ’80s and ’90s. America was on top, we had a balanced budget, democracy was on a roll and Francis Fukuyama had just written the “End of History.” That isn’t the world my daughter is growing up in, but if I do my job right, I might be able to deliver it to her as an adult and for her kids.
It was long assumed that defense tech was not a suitable area for venture investing because it could never achieve the returns in time-frames limited partners are looking for. Why was that the case, and how different is the landscape now compared to five years ago?
In times of relative stability, the defense industry consolidates, and regulatory capture plus lack of urgency make it hard for new entrants to compete. In times of crises there are expanding budgets and intense political pressure for diversifying the defense industrial base. This frees up the space, the will and the capital for new entrants to be successful.
Related, we’re also seeing a fundamental change to the exit market in defense. Traditionally it was IPO or bust because M&A exits haven’t been attractive in defense. The big primes are the most obvious acquirers, but they tend to be valued at 1X to 2X revenue by the market. This makes them extremely averse to acquiring startups for much beyond that range. Compare that to an 8X to 15X exit for a SaaS company and defense looks less interesting. The new defense unicorns, though, are becoming acquisitive themselves and are willing to pay traditional tech multiples for great technology and fast-growing opportunities. We believe this means we’ll have a good and getting better exit market for technologies that don’t reach IPO escape velocity.
As more generalist VCs enter the space, what effect will this have on the defense tech ecosystem? In what way is the increase in generalist VCs making you retool your investment strategy?
Valuations are up for all the “hot” defense deals, and it’s going to be hard (though not impossible) for the companies to grow into those valuations, particularly if defense stops being a flavor of the month. When we took over Army Venture Capital, there were maybe five-ish firms who did defense or dual use. At my last count it was over 100.
I worry that the vast majority of the new entrants are investing in and diligencing defense companies like any other tech company and that they are going to get badly burned. Real success in the defense market is more than a handful of grants, a contract and verbal interest. If an investor isn’t spending time on Capitol Hill, talking with warfighters, and interfacing with the real DoD buyers, they’re just throwing darts. I think two to three years from now, we’ll be back down to 20ish firms doing defense, and some of the frothiness will be gone.
National security means more than munitions. What are the most overlooked or undervalued defense tech segments, or ones most primed for growth, in the next 12 months? Conversely, are there any areas that are oversaturated?
Oversaturated? For sure. We don’t really need any more small unmanned aerial systems (sUAS), but there are plenty of interesting areas including: contested communications (both high and low bandwidth); positioning; navigation and timing technologies in GPS denied environments; advanced manufacturing techniques suited to edge manufacturing or to dramatically ramping up domestic production; directed energy technologies; and contested logistics. There are also tons of opportunities in things that dual-use VCs won’t touch (think things that go “boom”).
As an aside, I think dual use only is a huge mistake. If you want to do defense, do defense. Dual- use-only investors will miss the defense-first deep technologies that the Valley was built on. Besides, the idea that there is virtue in not investing in things that go “boom” ignores both the need for force to defend global freedom/deter conflict and the role of technology throughout the rest of the kill chain.
What role should non-dilutive financing programs play as a company builds its cap table?
Take all the non-dilutive financing you can get so long as (1) the grant is perfectly aligned with your roadmap, and (2) you have the current bandwidth to do the grant work without pulling people off of something else. Basically SBIRs are great if they fund what you’re doing anyway but bad if you let them distract your business.
The underappreciated aspect of a SBIR is that winning one is deemed a “competition” under the federal acquisition regulations, which means that once you win an SBIR, a government customer can contract with you without running another open competition. This is worth more than the capital, but only if you know that the SBIR doesn’t come with a government customer and that you have to do all the government capture work yourself.
The “valley of death” is a well-known risk for commercial companies selling to the government. How can startups bridge this gap before the dollars dry up?
Working with the DoD is like solving a combination lock. All the tumblers have to be aligned at the right moment in time but when they are, everything moves. What are the tumblers?
- warfighter interest/need
- an official requirements documents process
- congressional authorization and appropriations to the right budget line items
- alignment with a contract vehicle
- alignment with the “current thing” (China or Ukraine and not the global war on terror)Each of these is a process that moves at its own speed, but none except for the last move quickly. Avoiding the valley of death is working on all of these from day zero so that when you are ready to start selling to the DoD at scale, they are ready to meet you with a program of record.
Will venture help build the next U.S. prime? Will it look differently than today’s primes?
The past 24 months have been a challenging economic environment, but rising geopolitical tensions have been something of a counter-boon for defense tech. Is defense tech due for a reset?
Venture will build the next set of defense primes in both senses: companies that win direct major contracts with the DoD and companies that serve as integrators. Best guess is that they look much more nimble and largely avoid cost plus contracting in order to build more capability, at lower cost but higher margins for government customers. The great reset is already here; the impact might not be felt for a few more years, but we’re in the middle of it already.
For a deeper dive and perspectives from other notable investors in the defense tech space, including Silent Ventures, Andreessen Horowitz, Shield Capital, and Champion Hills Ventures, be sure to read the full article on TechCrunch.