December 12, 2019

This post is Part 2 of a 2-part series on Dual Use Tech and Accelerating Innovation in the Aerospace and Defense Sector.

A few weeks ago I published a short piece on the SBIR program and how some of the military services are using the program to expand and accelerate innovation. Now, let’s dive into exploring the impact of the US Air Force’s propensity to award SBIRs to companies with commercial backing or commercial traction.

As a private investor interested in Deep Tech companies, many of which could be dual-use companies, companies with technologies that could serve both commercial and military markets,  I am watching the evolution of the SBIR program as executed by the military services closely.  

This is because those companies I’ve invested in, or which I am currently evaluating, could potentially leverage additional non-dilutive dollars to further their technology. This is good for investors.  But, is it a slam dunk decision to invest in a company that has won an SBIR if it’s in the domain I’m interested in?  


An investor’s calculus still applies.  The company should be

1) Solving a critical problem

2) Serving market opportunities that are large – market size matters

3) Showing commercial traction  

1) Solving a critical problem. It starts with a basic premise: if you want to make money, you need to create something of value. The easiest way to do that is by solving problems for people, by fulfilling the needs they already have.  

2) Market size. Even if a company is solving a problem, that does not make it investable by private investors who are looking for a certain amount of investment return. Do enough people or organizations have the problem, and will they pay for it? Is the market $1B or more- is a rule of thumb that many use.  

3) Commercial Traction. Even if a company is solving a problem and tackling a huge market, does it have commercial traction? Commercial traction covers two aspects: 1) Can the company sell?  (Which the company controls);  and 2) What is the maturity of the market? (Which the company cannot control). Even if a company has some commercial sales, I tend to look and explore the surrounding market infrastructure, ecosystem, competition, substitute products, to assess if the ingredients are there for a market to exist, or is it too early and only certain elements of the market are growing. (An example is graphene chips; sure, there is chip technology, but, what about yield? What about software tools that allow for chip designers to design for graphene?  All these elements figure into a market being mature enough for most private investors to act.)  

Often, “dual use” companies with government investment are too early for private investors even if they have matured the technology beyond a mere prototype. I try to illustrate this point in the slide below.  Phase I is proof of concept, and phase 2 only starts to showcase a potential product.  One could invest early on and be one of the first investors in but risk the fact that the market takes time to mature, and the founders burn out, or have to continually raise dollars until the market gets to the point of responding.  Market maturity is a common issue, especially within the deep tech domain that I take an active interest in.  What I mean by this is that often times these markets take several years to hit an inflection point where there is widespread adoption.


I also get concerned with companies too focused on the government’s programs.  Companies need to be commercial first,  government second.  This is a subtlety that is hard for many founders to grasp.  I recognize a company that has the proper focus only after talking to the founding team   Often, after a quick chat with founders of companies that have been funded with grants I learn where their focus lies - isit in the tech or is it in the market? It’s okay to be focused on the tech, but not solely focused on the tech.  Unfortunately, a predominant number of the founders of companies who have SBIR grants or contracts in hand are focused on the tech and less so on the market.  They are tech-first companies, eager to develop interesting technologies - which the government wants and loves, and they are less concerned with iterating on the business model and figuring out a way to scale into the commercial marketplace.  

I am not interested in investing in another engineering services firm, of which many companies who apply for SBIRs are. Engineering services firms tend not to have a business model that scales, which, in turn, allow it to earn a financial multiple that is meaningful.  In addition, the exit opportunities are completely different.  This is not to say engineering services firms are not attractive businesses; it is just that they generally do not attract private investor interest on a larger scale.  

Finally, there’s an ongoing debate about how a startup should show commercial traction, especially in markets that have long sales cycles and are not as turnkey as web app companies. Several founders look to get Letters of Intent (LOIs). Indeed, showing LOIs is a good move; but, showing LOIs from other startups, by a startup, isn’t too compelling. It would be much more meaningful to get an LOI from an established company whose problem your company/technology is solving. Even further, could the company get a free pilot going, or a paid pilot. These latter examples of traction show market viability at levels much higher than simple LOIs. They take more time to get, but the process of getting them forces a startup team to learn about the true nature of the pain or gain that a prospective customer has. It enables the team to get deeper into the need of the market in general, and thereby build or pivot their product to suit the need. Or, abandon the quest altogether, if it turns out that there is no true demand. It’s better to learn about a lack of demand, or if a market is early in its gestation, sooner than later. The hard part is overcoming confirmation bias. Why is this important to investors? It shows true traction and burns down market risk. It shows the company can sell, even if there are no revenues involved. It covers a lot of bases.

Starting a company is exciting.  It is hard and is not for the faint of heart. The government helps aid startups by providing grant funding in turn for cutting-edge technologies. But the government doesn’t address commercial market viability. That’s up to the founding team. Only by addressing commercial market interest will companies gain investor interest. It’s usually not the other way around.  Exceptions are when a founder is Elon Musk -  who has done it before.  

I welcome comments and discussion on my musings!

Ellen Chang is working to accelerate defense innovation in her role as director of the Naval Portfolio at BMNT Inc.