Leveraging U.S. Capital Markets to Support the Future Industrial Network


Editor’s Note: This article is the result of a multi-track study at Business Executives for National Security into the industrial framework supporting U.S. security as introduced in Forging the Industrial Network the Nation Needs.

$56 trillion is nearly three times the size of the U.S. economy.  This vast pool of capital in U.S. capital markets — $46 trillion in public capitalization and another $10 trillion in private money – dwarfs that of China.  The New York Stock Exchange alone is four times the size of China’s Shanghai stock exchange.  America’s capital markets represent a critical, yet underutilized, strategic advantage for the Department of Defense’s ability to field new capabilities. Tapping U.S. equity and debt markets would enable the Department of Defense to remedy current capability shortfalls, fund technological advances from leading private-sector innovators, invest in generational transformation efforts across the military services, and upgrade antiquated global infrastructure to sustain U.S. forces. The Department of Defense should build upon on its participation in the venture-capital ecosystem by deepening its engagement with more commercial venture firms. It needs to reallocate research and development funding to provide more opportunities to small, medium, and large companies pursuing national security applications. Importantly, the Pentagon should adopt practices and implement programs that attract capital at scale for investment in defense, not unlike those used by the Departments of Commerce or Energy. Finally, there ought to be a comprehensive architecture of education, training, and exchange programs that builds experience and expertise amongst Defense Department professions in basic finance, capital markets, and financial engineering. The United States has no choice — America’s capital markets should be brought to bear to support critical defense priorities at scale and speed.

Conventional wisdom holds that legal, regulatory, and logistical hurdles in the Pentagon’s rigid process of annual appropriations, extended budget cycles, and complex procurement procedures make it nearly impossible for the Pentagon to access the public and private markets. The primary barriers though are neither legal nor technical. The Department of Defense has already shown an ability to be nimble in response to national emergencies. For example, when the COVID-19 pandemic erupted, it used its other transaction authority to act quickly outside the traditional contracting process to purchase vaccines and therapeutics. 

But when it comes to fiscal law and authorities, the Department of Defense tends to take a much more conservative approach, hewing closely to programs or initiatives expressly authorized by Congress in the annual National Defense Authorization Act. Changing this culture of risk avoidance will take serious effort by leaders at the Pentagon and on Capitol Hill, but it can be done. Here too, there are precedents. The Federal Ship Financing Program provided for a full faith and credit guarantee by the U.S. government to promote the growth and modernization of the U.S. merchant marine and U.S. shipyards. More recently, the Pentagon successfully dipped its toe into leveraging private capital and corporate funding to support early-stage research and technology companies. These limited venture-capital-related efforts are important but insufficient to enable the United States to retain or, in some cases, regain dominance on the battlefields of tomorrow. 



In the recently published National Defense Strategy, Secretary Lloyd Austin notes “our central charge is to develop, combine, and coordinate our strengths to maximum effect … to build enduring advantages across the defense ecosystem.” As the United States confronts its adversaries, it risks losing the relative advantage it has enjoyed since World War II in both its conventional defense-industrial base and in its capacity to integrate cutting-edge technologies into that base. China is rapidly closing the capability, capacity, and technology gaps with the U.S. military, particularly in the areas of artificial intelligence, autonomous systems, quantum computing, and advanced materials. Its military-civil fusion strategy is a potent cocktail of state-owned defense enterprises, commercial companies, and stolen intellectual property, all funded by the Chinese Communist Party and China’s capital markets, which are heavily influenced and sometimes even directly controlled by the government. China’s translational engineering capabilities have allowed the People’s Liberation Army to scale proven ideas into deployable systems at lower cost and with a velocity that is five times faster than the United States. Seven Chinese companies now rank among the top-20 defense manufacturers in the Defense News Global 100, second only to the United States with eight, having significantly closed the gap from just four years ago, when it had none.

In sharp contrast, Congress’ annual budget cycle hampers agility in a world where today’s most innovative technologies are being advanced by the private sector at speed. In the two years that it takes the government to appropriate funds, the commercial sector has already iterated three to four product designs. Unfortunately, this often drives companies into the bemoaned “valley of death.” Companies that have successfully developed and transitioned technology into prototype products and services must often wait too long to obtain the defense contracts needed to provide the revenue required to survive. A lack of financial agility, coupled with risk averse Defense Department processes and cultures more optimized for the 20th-century industrial age, foster a system that simply cannot cope with the modern pace of commercial technology development cycles. 

The Department of Defense and Congress should urgently take a series of specific actions to fully harness America’s capital markets and innovation forces. 

Build on the department’s current strong and successful participation in the venture capital ecosystem by deepening engagement with commercial venture capital firms, providing better access to customers and requirements, and facilitating technology integration into defense programs.

The Department of Defense has developed a broad range of successful approaches through which it has emerged as an important influencer and player in early-stage technology development. The initiatives include organic efforts such as the Defense Innovation Unit as well as several “innovation-hub” service efforts: AFWERX, SOFWERX, NavalX, Army Futures Command, and the Chief Digital and Artificial Intelligence Office. Most of these efforts leverage some combination of small business innovation research funding, other transaction authorities, broad agency announcements, and other processes and, as a result, serve as a catalyst for attracting private venture capital at leverage approaching 18-to-1 in the case of In-Q-Tel, a nonprofit acquisition arm of the intelligence community.

A significant amount of privately funded venture capital is now available that focuses on development of advanced capabilities and products, increasingly with dual civil-military application. The attempt to expand potential capital sources through the Pentagon’s Trusted Capital Program is an additional important step. However, there needs to be more frequent engagement in these communities with Department of Defense program managers along with targeted support from the Pentagon for a select set of emerging enterprises that have sophisticated entrepreneurs and investors and have the capability to develop robust products. The Department of Defense also needs to learn how to engage emerging growth technology companies at scale, along with system integrators and the subcontractors that bring niche expertise and convince them that a compelling return on investment exists in this national security channel. 

Redistribute current research and development funding to provide more opportunity to small, medium, and large companies pursuing national security applications. Create a reserve to accelerate the development and integration of breakthroughs, whether commercial or defense.

Large portions of the Pentagon’s scientific budget (appropriation 6.1 and part of 6.2) go to government-sponsored entities including organic research, development, and engineering centers, as well as federally funded research entities and university-affiliated labs. These efforts develop, but rarely integrate, advanced technology for defense purposes, and they sometimes get prioritized by the Pentagon over more advanced and much better-funded commercial technology. Rather than applauding itself for record research and development budgets, the Department of Defense should be looking to piggyback on the vast wave of private-sector research and development, representing more than 70 percent of total U.S. research and development funding, while identifying and supporting commercial technology that could be used to meet the Pentagon’s requirements. More defense funding would then be available to support either important translational and/or scaling efforts of private-sector innovation into defense programs where so often the United States is less effective than its peer competitors.

Adopt practices and implement programs to attract capital at scale for investment in defense like those found in infrastructure, energy, and other sectors.

The capital markets have repeatedly demonstrated the ability to deploy large amounts of equity and credit at lower expected rates of return, when provided government commitments through special-purpose programs such as have been created in infrastructure. These programs effectively reduce the cost of capital – which is particularly important in today’s rising interest rate environment. The Pentagon’s Defense Production Act Title III program already allows the Department of Defense to address areas where critical industrial capacity needs improvement by grants, purchase commitments, loans, or loan guarantees. Most recently, Congress authorized nearly $53 billion under the bipartisan CHIPS and Science Act to catalyze U.S. chip manufacturing and another $65 billion in broadband expansion to underserved areas as part of the new Infrastructure Investment and Jobs Act. All told, these taxpayer-funded investments being administered by the Commerce Department will unlock much more in private capital, translating into greater agility and flexibility relative to funding provided through the annual appropriation processes. 

There is tremendous opportunity to expand existing processes and develop ways the Department of Defense can both directly access the capital markets and lower the risk for companies through coinvesting, credit guarantees, and a range of other approaches. For example, the Small Business Investment Company program licensed by the Small Business Administration, enables qualified small business investment companies with expertise in certain sectors, such as defense and aerospace, to allocate up to 30 percent of their regulatory capital (generally their private capital) in a qualified small business deal. At the fund level, private capital is matched with Small Business Administration provided funds on a 1-to-2 basis (up to $175 million from the Small Business Administration for any given fund) so these funds can have substantial capacity. It is exciting that these small business investment companies can collaborate in consortiums to invest $50 million or more into a given deal, bringing a far greater level of investment than permitted in existing small business innovation research processes. An extension of this same framework could enable private capital to quickly invest much larger sums into small and mid-cap companies, if authorized. 

Further, the Department of Energy has implemented a broad range of grant, loan, tax credit, and guarantee programs, such as the $161 billion in tax credits for deployment of zero-carbon energy sources and $116 billion in grants for clean energy research and development included in the Inflation Reduction Act, which is attracting private capital by lowering the risk and cost of developing technology and transitioning it into production capacity. Lastly, the real-estate market has developed a framework of agency support, such as mortgage-backed securities supported by government-sponsored programs at Fannie Mae or Freddie Mac, which adjust risk profiles and facilitate capital market activity. The Department of Defense can adapt these and other approaches to enhance the risk-adjusted return profiles for development of defense technology and acquisition of the innovations that follow from it. 

Accessing such private capital also reduces risk and cost because those funds can be dynamically available in adequate amounts to support program needs with agility. Consequently, the benefits of multiyear procurement can be gained and the holding period on drawn capital can be efficiently minimized, with many estimates achieving 5 to 10 percent or more in savings, while lowering schedule risk. It can also make available funds needed to rapidly address critical readiness issues, such as the significant challenge in Navy ship repair due to dysfunctional, World War II-era drydocks. Lastly, private capital could be utilized by both Department of Defense program offices and the private sector on short notice to rapidly accelerate lines of effort, whether on a critical research and development or an increase in production to address mission requirements. 

Develop an architecture of education, training, and exchange programs at the Pentagon that builds experience and expertise among defense professionals in basic finance, capital markets, and financial engineering. 

As with the Defense Digital Service, or the introduction of innovative industrial processes under Secretary of Defense Robert McNamara in the 1960s, the Department of Defense should build a rapid response team of financial analysts, traders, and portfolio managers to “mass” capital, connect capital to companies and innovators, negotiate with financial counterparties, and manage the risk (and inevitable conflicts of interest) to finance our most pressing defense priorities. In parallel, and not unlike the Defense Science Board or the Defense Business Board, the Department of Defense should establish a Defense Capital Markets Board to provide senior leaders in the Pentagon with new ideas and counsel on using America’s public and private markets to catalyze defense innovation, build relevant infrastructure, and scale procurement and manufacturing. The Pentagon should also work with leading business schools and related graduate programs across the country to create mid-career finance programs for Defense Department professionals. Pentagon executives would have the option as well to attend standard Master of Business Administration programs, but the idea here is that civilian and uniformed personnel would flow freely between the Defense Department and the civilian finance sector.

We applaud Austin’s recent announcement of the formation of the Office of Strategic Capital. This is an important step. The office should have a broad mandate that looks across small, medium, and large companies and engages both the private and the public markets in connecting capital to opportunities. Its leaders should view the capital markets as yet another warfighting domain in which the Pentagon’s multi-trillion-dollar balance sheet can be weaponized. Its annual budget of over $800 billion can co-fund and build critical technologies, catalyze the formation of entirely new industries, and, more than building weapons, can be invested against our adversaries along the many battlefronts, from technology to input materials.

Taking all these steps can integrate the extraordinary equity and debt funding capabilities of U.S. capital markets into the build-up of a future defense industrial network that no other country in the world can match. We’ve done this before to powerful advantage during World War II. The rise of a peer competitor in Asia and ever more capable conventional weapons, increasingly developed even by smaller powers, leaves the United States with no choice. America’s capital markets ought to be brought fully to bear to help protect our national security. Senior leaders within the Defense Department and in the U.S. capital markets need to begin a dialog to figure out how to be creative and courageous in making it so. 



Gen. Joseph L. Votel, U.S. Army, (ret.) is president and chief executive officer of Business Executives for National Security and is the former Commander of U.S. Central Command and U.S. Special Operations Command.

Frank Finelli is managing director at the Carlyle Group focusing on investments in the defense and aerospace sector where he has led numerous acquisitions and developed Carlyle’s cross-portfolio value creation and risk reduction.

Samuel Cole is principal and co-founder of Stonecutter Ventures, a private equity investment management firm, with experience seeding companies across fintech, defense technology, manufacturing, and robotics.

The authors would like to thank Peter Crail, Marta Lazowska, Michaela Davis, and Giuliano DiRissio for their assistance in supporting the research required to write this article.

Image: Department of Defense