How Will the Pandemic Affect National Security Innovation?
“Hi team, so there is bad news and good news. We need to move very quickly, but we will survive this.”
“This” being a COVID-19 induced recession. The second week of March was an inflection point for many across the world. As a founder of a tech company with commercial and defense customers, I have concerns for the early-stage companies with defense applications. With the massive economic downturn came panicked investors trying to determine which companies in their portfolios would survive. They reached out to learn how much cash we have, if we can do layoffs, and if we would ultimately survive. My experience was not unique. My peers went through the same set of questions from their investors. The world of high-tech startups, like many other major industries, is in jeopardy, and the decisions these companies make will have lasting ripple effects for U.S. national security.
Not only does the United States rely on startups to maintain the lead in defining and monetizing new technology, but the Department of Defense also just started to create a stronger, more expansive, and more diverse defense industrial base that includes these leading-edge technologies. CEOs are taking a hard look at how their companies will fare during this storm. Some contingencies they are planning will pull them out of the defense ecosystem. Some companies won’t make it through the next year. But there are things the Department of Defense can do to strengthen the U.S. national security innovation base through speeding cycles for new Small Business Innovation Research Grants and Commercial Solutions Openings. The Pentagon should also be incentivizing Program Executive Offices to spend budget on non-traditional defense contractors, and surge funding for defense-specific activities within commercial companies. Additionally, Congress should modify the “affiliate” rule for the Paycheck Protection Program and Emergency Injury Disaster Loan to ensure early-stage defense technology companies are eligible to apply.
Non-Traditional Defense Contractors: A Crucial Part of the National Security Innovation Base
Non-traditional defense contractors are companies that are not focused solely on defense work. These companies have dual-use technologies that are leveraged in both defense and commercial industries. They are also especially crucial given that the gap between commercial and federal R&D has flipped and drastically widened since the late 1980s.
Commercial businesses and startups are the leading edge of innovation. Federal R&D spending peaked in 1964 during the height of the Cold War. Then, by 2018, the percentage of federal expenditures represented only 21 percent of total American R&D, while commercial R&D rose to 70 percent of the total. Creating the agile resurgence needed for waging war in the 21st century is impossible without leveraging commercial technologies, as the future of warfare increasingly goes online and digital.
The incorporation of commercial technologies into warfighting capabilities also has a large second-order effect. Economists have shown time and again that increased competition drives innovation. The addition of more companies into the U.S. defense base not only directly introduces new technologies, but also drives the entire industry to create better capabilities for our warfighters. There are only a handful of major defense primes, but thousands of new technology companies are started every year; these startups play a crucial role in the national security innovation base.
A “Black Swan”?
The world is reeling right now. Not just because of the personal loss and despair created by the global pandemic, but also because many are losing their jobs, retirements, or businesses as the economy recedes. The S&P 500 had its worst quarterly opening in history and the Dow Jones Industrial Average has dropped almost 30 percent since its high in mid-February. During the downturn, new investments from venture capitalists are significantly suppressed. This affects startups’ abilities to raise capital. With the aggressive growth rates needed for many technology companies, lack of investment will cause them to die or undergo massive layoffs. Sequoia, one of the world’s most venerated venture firms, sent a memo to their founders calling COVID-19 and its ripples a black swan. Whether it is a black swan or something else — perhaps a “gray rhino” or “pink flamingo” — the venture and tech worlds were taken by surprise. Sequoia warns it may take “several quarters” to get the pandemic under control and “even longer” for the market to recover. This memo carried a strong undertone of impending layoffs and shutdowns.
Action and Contingencies
Even amid uncertainty and volatility, leaders create and execute contingencies. The common maxim of former Intel CEO Andy Grove was, “Only the paranoid survive.” This is certainly what I reassured myself while poring over the particulars of several worst-case scenario contingencies over the past month. It is worth noting that this involves a reversal of “normal” entrepreneur reasoning: from “How much can we change the world?” to “Just don’t die.”
This is reinforced by investors describing the differences between two kinds of CEOs: wartime and peacetime. As described by Ben Horowitz, peacetime CEOs maximize opportunity while wartime CEOs fend off existential threats. Many entrepreneurs became wartime CEOs over the last month, as our paths toward survival narrowed. For non-traditional defense contractors, the ideal course of action is to maintain commercial revenue along with defense-based infusions. However, necessary contingencies will draw some of these startups out of the defense industrial base through attractive foreign investment terms, the need for narrowing customer focus, and/or general startup attrition and shock.
Even when the economy is strong, startup survival is dependent on the ability to acquire new capital investment to create stable market positions or to amplify growth. I was just ramping up a fundraise for Geosite as the first U.S. cases of COVID-19 were confirmed. We decided to proceed with the fundraise as we watched the markets tumble because we saw an opportunity to accelerate while organizations needed tools to make remote and distributed operations more efficient. Immediately, the investment market cooled while investors struggled with their own stability to support their portfolio companies.
As startups dig deeper through first, second, then third tier investors there will predictably be an increase in foreign investment appearing on the capitalization tables of promising startups. On one of my slides of contingencies is the option to accept investment from foreign insurance corporate venture capitalists, who value our technology in their core market. As a leader who does not want to see the incredible work we have done taken out by a black swan, all options are on the table. Even if those options introduce foreign ownership, control, or influence. I won’t let the risk of foreign ownership, control, or influence issues kill my company. And neither would any other responsible CEO. If we must pivot away from defense to keep building, we will. And in the future, hopefully, we would return to defense applications. I have deep roots in national security and started my company in order to help solve a massive capability gap. Though letting foreign investors onto our capitalization table is far down on our list of contingencies, it is there. I guarantee it is much higher on many other executives’ lists.
As investment decreases and cash becomes scarce, many startups have already begun massive rounds of layoffs. Behind the scenes are calculations about what work will cease as these companies lower their headcount. If you reduce the number of engineers at the organization, only some of the previously planned projects are going to be completed. The company decides which business units to eliminate and which customers to stop serving. The Pentagon needs to ensure they are not the vertical that companies decide is too risky in the current economic environment. Despite the stability of a long-term contract or the massive defense budget, the process of securing long-term, high-value contracts is still opaque and convoluted to most commercial tech CEOs and their investors. To most startups, the Defense Department is a very unpredictable customer — more attractive to a peacetime than a wartime CEO.
Attrition will also decrease the number of startups that make it through 2020 at all. During the 2008 recession, many startups did not survive. The same will happen during this global pandemic. This will directly lead to a decrease in the number of high-tech startups available to fuel U.S. national security and technology leadership. This is the time to invest heavily into working with the early-stage technology companies that the Pentagon deems to have promising technologies to help fight and win future wars. There are multiple ways in which this can be accomplished.
Strengthen the National Security Innovation Base
First, the Paycheck Protection Program and Emergency Injury Disaster Loan through the Coronavirus Aid, Relief, and Economic Security (CARES) Act gives small businesses loans to reduce the number of companies that will go out of business or conduct mass layoffs in the next few months. However, these programs include a determination of what counts as a small business that employs an antiquated definition of the term “affiliate.” The Small Business Administration released new interim guidance on April 2, which expands flexibility for franchised restaurants as well as churches. However, the guidance still does not address affiliation through investors. If the definition is not modified to allow venture-backed companies to apply, many early-stage startups will not make it through the next few months. This is not only important for the Department of Defense, which has gathered many new sources of technology from these fledgling companies, but also for the whole of U.S. national security. American economic strength is important for global stability. When these companies die, the United States will have fewer companies to lead us out of this economic emergency.
Second, to ensure opportunities are offered quickly enough to keep the defense innovation base strong, it is important that contracting cycles and opportunities are sped even further. The next Small Business Innovation Research Broad Agency Announcement was pushed by a few weeks. These types of timescales, while typically just irritating, will now determine life or death for dual-use technology companies. Now is the time for the Department of Defense to not only speed cycles up, but also to reach even further across the technology industry. The primes will survive the downturn, but the startups and commercial technology that increase the capabilities of the U.S. military may not. Focus on assisting and elevating small and growing technology companies. Silicon Valley needs options. Be the option they turn to.
Third, many non-traditional defense contractors have vehicles for anyone in the Department of Defense to engage with immediately. The AFWERX team has moved mountains to create funding pathways. As they uncover new technologies with national security relevance, they create a contracting vehicle for anyone in the Pentagon to rapidly assess and deploy. Technology from 1,300 non-traditional defense contractors can be immediately leveraged through their current contracts. Now is the time to use these vehicles. If the technologies need adaptations to meet more specific user needs, the Air Force has also created a process for “Direct to Phase II” grants that will provide companies with funding to complete adaptations needed by warfighters. Incentives also need to be created to amplify these efforts at scale. Program Executive Offices, now more than ever, need to have a portion of their budgets allocated to companies that are not defense primes.
Fourth, and most specifically, now is the time to move many technology companies over a major hurdle: jumping through the policy and technological hoops for gaining the authority to operate on defense networks. As a researcher on innovation in necessarily bureaucratic and hierarchical organizations, I have been both unsurprised and frustrated by the number of bureaucratic hurdles that often keep the Department of Defense and Silicon Valley from working with one another. Technology companies with commercial revenue typically look at the hurdles to getting involved with most parts of the military and decide they cannot risk the resources. For example, the Federal Risk and Authorization Management Program is estimated to cost $2.5 million, and at least a year, to make it through the process — then the company can get to work on an Authority to Operate for another 4 to 6 months and $500,000. Within the Air Force, there have been mentions of a “continuous Authority to Operate” becoming more broadly available, but they have not become a common nor is there a clarity on timelines or requirements for commercial software to be launched on military systems. Commercial companies have the capacity to work on these adaptations needed for military systems right now while commercial demand is decreased. The Pentagon needs to boost funding for these types of defense-specific activities for non-traditional defense contractors.
The currents were already moving in a good direction when the pandemic arrived. The Department of Defense just needs to steer into these currents. Defense capabilities are advancing through new acquisitions opportunities for small businesses and startups. Through the Air Force’s novel use of Small Business Innovation Research grants, and through Commercial Solutions Openings from the Defense Innovation Unit, contracts and pathways for branch services to rapidly prototype, purchase, and deploy novel technologies have surged forward. The Department of Defense needs to keep moving aggressively to ensure this momentum and progress is not lost. This could be the generation of investors who remember that it was the Pentagon who rescued their portfolio. In the past, our government work was considered “high-risk,” but now it is our most stable revenue stream and may be what keeps many tech companies afloat through this global crisis. The divide is economic, not moral. The economic calculus is different right now and the Pentagon should seize this opportunity.
Rachel Olney is a Stanford University PhD candidate and the Founder and CEO of Geosite Inc. Her research focuses on Innovation in Bureaucratic and Hierarchical Organizations with much of her research on Cyber Command. As the CEO of Geosite she leads a venture capital backed Silicon Valley startup disrupting the geospatial industry.