When U.S. software program companies think about their major markets, many largely keep away from the protection sector. That’s true whether or not they’re established tech corporations or early-stage startups. The explanations are clear: Pentagon procurement has traditionally, and largely, centered solely on the acquisition of bodily provides and tools, yielding processes unsuited to software program licensing. Bureaucratic challenges additionally frustrate corporations as a result of they result in lengthy gross sales cycles. And lots of tech workers have refused to work on protection initiatives, citing cultural and moral issues. With these challenges, funding by enterprise capital and different sources has been laborious to return by for companies working in or seeking to develop into the protection market.
Nevertheless, there have at all times been exceptions, like Amazon, Microsoft, and Google cloud companies — or early-stage rising know-how startups, just like the 50-person startup Pendulum — that expanded to the protection market quickly after discovering business product-market match. These exceptions show that U.S. software program corporations can succeed within the protection market. As well as, a number of elements are making the Protection Division’s $800 billion finances extra accessible to those companies. (We give attention to the U.S. on this article as a result of it’s laborious to attract parallels to different nations’ very completely different startup cultures and protection markets.)
Our expertise working with each startups and the protection trade leads us to imagine that now’s the time for founders of increasing software program companies to think about the protection market. On this article we’ll clarify why and lay out a plan for promoting to the federal government whereas attracting funding alongside the best way.
Why now?
Three elements make the protection market a way more interesting vertical for U.S. software program startups at the moment.
First, the Pentagon is a motivated buyer and has already made some strikes to court docket software program distributors. Decided to maintain tempo with China, it has elevated the pace at which it procures and integrates rising applied sciences by revising various its current acquisition processes. The Protection Division has additionally established commercial-friendly organizations (such because the Protection Innovation Unit and AFWERX) and software-specific procurement processes (such because the Authority to Function and Platform One). It has created cloud software program certifications equivalent to FedRAMP and partnered with AWS to supply GovCloud to make it simpler for software program distributors to fulfill the safety necessities to get their product in entrance of presidency workers. These modifications have made it potential to unfold business software program to the federal government.
Second, the protection market is steady amidst many business market headwinds. Widespread layoffs and the collapse of Silicon Valley Financial institution have roiled business markets. For software program corporations, the market downturn has triggered return on gross sales spending to drop, prospects to slash IT budgets, and huge enterprise gross sales to take longer to shut. In distinction, the Protection Division is a steady buyer. The Pentagon maintains a constant and huge finances, with excessive switching prices for his or her software program options. As soon as an organization lands a recurring income contract, annual income allocations are important and low threat. This offers the Pentagon qualities much like the biggest, most engaging enterprise-sized business prospects whereas additionally making it a extra steady buyer.
Third, non-public capital traders are more and more supporting corporations within the protection market. The worth of enterprise capital offers into aerospace and protection tech was larger in every of 2021 and 2022 than in all of 2010 by 2019 mixed. We imagine that the upward pattern is attributable to investor want to have interaction a crucial, but digitally undisrupted trade. And it appears to be working: Protection contracts in areas like cybersecurity and AI are enabling traders to seize returns on funding. Touchdown recurring income from federal authorities contracts exhibits enterprise firm maturity and the power to handle advanced wants. For AI information labeling startup Scale AI, for instance, increasing into protection meant a trajectory-defining $250 million contract a yr after their Collection E. High-tier companies like Andreessen Horowitz, Founders Fund, and Lux Capital and defense-focused companies like America’s Frontier Fund and Defend Capital are amongst these investing within the house.
The best way to sort out the protection market
Regardless of the attraction, 1000’s of startups depart the protection market. Corporations fail within the protection market as a result of they mistake non-recurring income from the Pentagon as success after which get trapped within the “valley of demise,” crumbling earlier than they construct a scalable product worthy of recurring software program subscriptions. (Whereas most software program corporations purpose for a recurring income mannequin to achieve stability and scale, that is much more crucial for corporations within the protection market, during which new contracts current even increased up-front R&D and buyer acquisition prices.) Alternatively, corporations additionally fail by focusing solely on producing annual recurring income by big-ticket gross sales like applications of report, operating out of cash chasing long federal sales cycles.
Or they redesign their business merchandise to satisfy the precise wants of particular person protection prospects. Such bespoke specs restrict the utility of the product to different protection prospects, stopping scale.
In distinction, we’ve noticed that corporations which have efficiently scaled throughout the protection market have taken these three techniques:
Use Industrial Traction to Safe Early Protection Income
A business firm ought to enter the protection market solely after it has achieved business product-market match, the place progress efforts are clearly leading to buyer traction. This enables the corporate to give attention to protection prospects that align most carefully with its business prospects whereas stopping it from over-specializing particular protection merchandise which might be incapable of wider scale. As well as, business gross sales assist these corporations keep afloat throughout lengthy federal gross sales cycles.
For such an early-stage firm, step one into the protection market have to be to safe non-recurring income, i.e., one-time grants, equivalent to Small Enterprise Innovation Analysis (SBIR) awards and/or Speed up the Procurement and Fielding of Revolutionary Applied sciences (APFIT). These alternatives present the funding mandatory for corporations to keep away from what is named the “valley of demise” — during which an organization perpetually achieves one-time income contracts which might be unable to ship adequate returns on funding to justify prices — by figuring out protection income potential and potential protection product-market match whereas mitigating the prices startups face within the protection market.
The important thing, nevertheless, is to not mistake non-recurring income for fulfillment, and even significant enterprise. Moderately, non-recurring income contains the coaching wheels for the earliest-stage corporations to first discover protection product-market match and construct relationships earlier than taking the following steps to safe recurring income.
Use Present Channels to Get to Recurring Income Sooner
An organization can reduce down the time required to maneuver from non-recurring income to recurring income by leveraging current gross sales channels — massive gamers already within the enterprise of promoting to the protection market. The commonest channel companions are prime protection contractors like Lockheed Martin, Boeing, and Northrop Grumman. “Primes” are intimately acquainted with procurement processes and management a number of channels for delivering options by the Pentagon’s 2.2-million-person paperwork. Partnering with these primes permits corporations to rapidly ship product to authorities workers to allow them to validate product-market match as quickly as potential.
The primes’ gross sales channels provide a number of alternatives to validate product-market match. For instance, Utilized Instinct, an autonomy software program firm, began within the automotive sector however recognized a protection market want for its choices. As a primary foray into protection, they subcontracted with prime contractor and automobile producer Basic Dynamics to bid on an autonomous automobile design in 2021. Since then, they’ve been in a position to win significant direct protection enterprise. Primes additionally provide a possibility for software program corporations to combine their product inside a major’s {hardware} platforms so corporations don’t must construct their very own {hardware} or persuade authorities patrons to join annual software program subscriptions. Overwatch Imaging, for instance, places their imaging software program on cameras that prime contractor L3Harris sells on to the federal government, bypassing the necessity to have authorities patrons subscribe to Overwatch Imaging’s software program instantly.
There are some downsides to working with primes. As {hardware} or companies companies, their meager software-reselling efforts might generate income at ranges which might be uninteresting to startups; additionally they typically squeeze their suppliers on fee phrases. Corporations may additionally get caught as subcontractors solely to be acquired for a middling value. For corporations that resolve that partnering with a major is simply too dangerous, there are different current channels to discover, equivalent to massive tech platforms like AWS and Snowflake. Their marketplaces are inclined to work higher with software program companions — although massive tech platforms provide much less worth to startups within the protection market than primes..
Regardless, the worth corporations discover in working with any of those current gross sales channels is saving money and time in studying whether or not promoting to the Protection Division is a compelling enterprise technique.
Construct a Devoted Crew to Scale Protection Gross sales
Profitable commercial-first corporations with validated protection product-market match can scale their product and obtain sustainable recurring income by establishing a devoted federal gross sales workforce. Correctly establishing a federal workforce permits corporations to chase recurring income alternatives and create a steadfast protection software program enterprise.
Industrial offers shut in a matter of months and bigger offers take nearer to a yr, whereas federal offers sometimes take properly over a yr. Thus profitable business corporations getting into the protection market compensate their federal gross sales groups by multi-year quotas and pay commissions on renewals to make sure deep, long-term product deployment. These corporations measure federal gross sales success by specializing in upcoming pipeline and buyer touchpoints.
Federal gross sales require salespeople who possess the uncommon mixture of getting federal buyer data and relationships (normally by public sector expertise), in addition to a persona suited to the team-based setting mandatory to shut advanced federal offers, relative to business salespeople, who are usually territorial and aggressive.
The target of the gross sales workforce is to attain the annual recurring income essential to develop a powerful protection enterprise. The preferred aim is for the corporate to be included in Applications of Report, which means that they’re engaged on a venture tied right into a line merchandise written within the Protection Division’s annual finances. Nevertheless, there are different choices to seize recurring income. One widespread pathway is thru the decentralized Operations & Upkeep (O&M) contracts extensively out there throughout the Division. Accessing these kinds of funds requires constant coordination with operational army personnel, however acquiring the contracts could be extremely easy (for instance, the GSA schedule). That is analogous to bottoms-up, product-led progress somewhat than a centralized method.
Discovering the fitting investor backing
Whereas corporations can search investor assist at any of those steps, corporations have the best probability of elevating funding after discovering product-market match within the protection market. Three classes of enterprise capital (VC) companies function within the protection market: Giant companies, defense-oriented companies, and strategic traders.
Giant VC companies are generalist companies possessing billion-dollar-funds, equivalent to Andreessen Horowitz, Basic Catalyst, and Founders Fund. They fund corporations that may develop into category-defining unicorns. The explanation for that is that VC returns are pushed by a couple of profitable outliers (typically referred to as the Energy Legislation): The bigger the fund dimension, the larger particular person corporations must develop into to return the fund’s capital. Due to this fact, headline-grabbing VC protection investments typically spotlight corporations like Anduril that solely pursue protection gross sales as a result of they’re able to difficult current prime contractors. However business corporations getting into the protection market may safe checks from giant VC companies after demonstrating the potential for enormous scale throughout the Pentagon. For instance, whereas Scale AI solely had a $750,000 non-recurring SBIR earlier than elevating their $325 million Collection E, the extra funding helped them get a $250 million protection contract a yr later.
Many protection investments additionally come from specialist mid-sized VC companies that explicitly assist corporations scale in protection. For instance, America’s Frontier Fund and Defend Capital have conventional enterprise capital fund buildings however dedicate their sources and networks to assist corporations promoting to protection. Specialist VCs don’t want category-defining success to make the identical return permitting them to assist a wider vary of corporations promoting to protection.
Strategic company traders equivalent to Lockheed Martin Ventures and Boeing’s HorizonX-AE Industrial research rising applied sciences and provide strategic partnerships on prime of incomes returns. For instance, Lockheed Martin Ventures’ efforts to scout AI/ML tech led to its funding in Fiddler. Strategic traders take care of their mother or father company’s strategic pursuits and might even assist startups develop into a vendor to their mother or father company (L3Harris invested in Overwatch Imaging whereas adopting their know-how). Strategic authorities traders equivalent to In-Q-Tel, the U.S. intelligence neighborhood’s enterprise capital outfit, prioritize know-how relevance. Strategic traders can typically assist with getting non-recurring funding, being a channel companion on the earliest levels, and offering credibility for the following spherical.
The protection market is primed to be remodeled by cutting-edge software program. This sea change needn’t be restricted to a choose few defense-only tech startups or contractors. Protection is usually a profitable further vertical, for at the moment’s U.S. business software program corporations—one that appears significantly engaging at the moment.