Silicon Valley VCs rush into defence technology start-ups

The investment in start-ups in the military technology sector is growing as the US government becomes more confident that it will award lucrative contracts to Silicon Valley firms developing cutting-edge defence technologies.

US venture capitalists agreed to more than 200 deals in defence and aerospace worth almost $17bn during the first five month of 2019. This is more than what was raised by the sector for the whole of 2019 according to PitchBook.

The boom in the artificial intelligence industry is mirrored by this boom in the start-ups of other sectors in the tech sector. However, investment in these areas has dropped in recent months due to a general downturn.

PitchBook data show that US investment into defence start-ups has risen from $16bn to $33bn by 2022. Investors invested a record-breaking $14.5bn in such start ups during the first quarter of 2019.

Silicon Valley has shunned defense technology in the past, fearing its association with controversial conflicts overseas and wary of Pentagon’s notoriously risk-averse and slow procurement process that favours established defence contractors.

Interviews with over 15 investors and entrepreneurs have revealed that this initial skepticism has now given way to the belief that start ups will finally be able to capture a large share of US defence budgets. The US defense budget has grown dramatically in recent years, reaching a record-breaking $886bn by 2024.

Andreessen Horowitz, Sequoia Capital, and other large VCs have started to invest in defence companies as well as “kinetic” weapon systems for the first-time, a reference to active war including lethal force.

“We’re seeing more VCs say they’re comfortable investing in startups doing. . . Mike Brown, former director of defence innovation at the US Department of Defence and partner at Shield Capital in San Francisco, said that tech can be used to have a kinetic impact.

Sequoia Capital, according to people familiar with the deal, led a $6mn seed round into Mach Industries in early this year. Ethan Thornton, a 19-year old MIT dropout who started Mach last year, develops weapons and defense systems powered by hydrogen. Sequoia refused to comment.

Anduril Industries is a defence technology company worth $9bn, with Andreessen Horowitz as its largest investor. It recently announced that it was in discussions to create its first weapons, creating a loitering munitions version of its drones – aerial weapons systems which can wait passively until they find a target before attacking.

Anduril, a Los Angeles-based company, won a contract worth $1bn from the US Special Operations Command last year to integrate systems that could identify, track, and intercept hostile drones.

Teresa Carlson said, “We are at War, it’s Real.” She previously led Amazon in its efforts to sell AWS cloud computing services to the US Government and recently joined Silicon Valley venture company General Catalyst, as an advisor. “We have to consider how we can use tech in new ways,” said Teresa Carlson, who previously led Amazon’s efforts to sell its AWS cloud computing service to the US government. She recently joined Silicon Valley venture firm General Catalyst as an adviser.

General Catalyst launched in April a global resilience practice to support defence and intelligence firms. The company has $33bn of assets under management.

According to Brown, the Russian invasion of Ukraine at full scale has changed US military interest for commercial technology.

The Ukraine war was fought using a combination high-tech systems, such as satellite communication, data intelligence and drones.

Elon Musk and HawkEye 360, a Virginia-based defence company, have supplied Ukraine with satellite radar imagery to detect Russian convoy movement and internet connectivity resistant to Russian jamming attempts.

Brandon Tseng said, “The appetite for AI-powered drones and fighter pilots has changed dramatically since we began in 2015.” Shield AI is a $2.7bn start-up that produces artificial intelligence-powered drones and fighter pilots. “That was the year that we presented to 30 seed investors, and received 30 ‘noes’. After the Russian invasion of Ukraine, suddenly, everyone was paying attention. “The funds that thought it was taboo are no longer doing.”

Six defence tech unicorns – start-ups worth over $1bn – have emerged as a result of the funding flood: ShieldAI (HawkeEye 360), Anduril (Rebellion Defense), Palantir, and Epirus.

Some defence tech entrepreneurs cautioned, however, that the public procurement process has improved but is still painfully slow.

ShieldAI founder Tseng warned about the “valley or death”, which is the time between developing a new prototype and receiving a contract from the government. During this period, young companies will likely run out of money and fail.

According to the founder and investor of a San Francisco venture firm, large contracts are awarded to companies like Anduril or ShieldAI.

The person stated that it is “still incredibly difficult to sell to US government. Founders face a lot of unfair advantages, and lobbyists (for the big defense contractors)”. There are many highly valued defence firms that have not performed up to expectations.

Brett Granberg, founder of Vannevar Labs, said that the key to success is selling services directly to those who are carrying out missions. If you crack the code, you can unlock contracts worth eight- or nine-figures.

According to two sources with direct knowledge of the situation, Vannevar Labs revenues increased from $3mn in 2013 to around $25mn. This was due to a surge in government contracts. The company that analyzes global communications in order to provide military intelligence raised $75mn from investors, including Felicis Ventures, in January.

The US government has created a number of agencies in recent years to encourage the private sector to develop tech for national security. These include the Defense Innovation Unit, which was established in 2015, and Afwerx, which was founded in 2017 to allow private companies to sell innovative technology to the US Air Force.

In 2019, the US established a military branch named Space Force, which will conduct military operations in outerspace. This has sparked a new round in private investment in defence technology focused on space warfare. Musk’s SpaceX is one of the largest private winners. It has received large contracts for helping to build missile-tracking and communications satellites.

A significant number of investors now believe that recent technological advancements around artificial intelligence has provided an additional onus for Silicon Valley groups in order to assist the US defence efforts.

Dan Gwak is managing partner of Point72 Private Investments. He says that the common wisdom among founders has been to not build a startup that relies on selling into government.

He said that the rapid growth of AI was a “technological advancement which I believe can change the global superpower balance.” The last time this happened was when the atom-bomb was developed. “Finally, we are seeing the government take steps to win this tech race.”