Venture Capital

Agencies start their own investment funds to bring new technologies to government.

Venture capitalists make high-risk investments in startup companies developing cutting edge technologies. Now the government wants to be part of that action.

At the urging of Congress, NASA has become the latest agency to set aside money for a venture capital fund. The CIA's In-Q-Tel, started in 1999, is the longest-running federally funded venture capital fund, followed by the Army's OnPoint Technologies. The Navy has been looking into developing its own fund, and some in the venture capital community expect to see more agencies doing the same. "I believe that success breeds replication," says Donald Tighe, an In-Q-Tel vice president. In-Q-Tel has received an increasing number of questions from officials at other agencies interested in setting up their own funds.

Anytime the government approaches territory normally reserved for the private sector, people want to know why. Do taxpayers really need to fund startup companies when plenty of private venture capital firms seem to be willing to take on the risk themselves?

"The government doesn't fund science as willingly as it used to, so a lot of technology creation in our society is getting outsourced to venture capitalists," says Jonathan Aberman, managing director of the Reston, Va.-based venture capital firm Amplifier Venture Partners. That means "a couple of thousand people nationwide are deciding what ideas get developed," and they're making those decisions based on money, he says. If an agency has its own fund, adds Aberman, then it can make sure technology necessary for its mission gets developed.

Federal funds also help the government find out about groundbreaking solutions, say venture capitalists. "There's a lot of technology being developed today outside of government, and government needs to know what that technology is if it's going to be innovative," says Mark Heesen, president of the National Venture Capital Association in Arlington, Va.

Most federal venture capital funds want the companies they invest in to eventually become government contractors so they will pass on their technology to agencies. Without the federal investment, the startup might focus exclusively on the commercial sector because it's more lucrative, venture capitalists say. And riskier startups with potential to provide essential technology to the government might not be able to get any funding at all, says Bruce Held, senior policy researcher at the RAND Corp. in Santa Monica, Calif., which worked with the Army while it was setting up its fund.

"To their great credit, it didn't take a sputnik or a 9/11 for [the CIA] to realize that the pace of innovation was suddenly ahead of their ability," says Tighe. In-Q-Tel has invested in 90 companies that have delivered 120 technology solutions to the intelligence community, including a system that cleans up documents that have been degraded by environmental and other factors. Tighe adds that 80 percent of funding recipients did not have any interaction with government before, and 70 percent sold to the government following In-Q-Tel's investment.

The Army is about to start using technology that measures the remaining power in batteries, developed by Herndon, Va.-based PowerPrecise Solutions Inc., which received an investment from OnPoint in March 2004. The Army expects to save $65 million a year with the new product. It has put $61.8 million into the fund since Congress mandated its creation in the fiscal 2002 Defense Appropriations Act.

"We'll be unsuccessful if there is not a product at the end of the day in the hands of the soldiers," says Jason Rottenberg, OnPoint's managing director. He says a big part of his job is to help companies develop their business so they can become military contractors. "We bridge the gap by helping them understand the customer," he says. Companies that receive federal venture capital funds must still go through the normal competitive bidding process.

A challenge is finding the right degree of government involvement in a fund, says Jonathan Koppell, Yale School of Management associate professor. "You don't want the government to be too thickly in the hair of the people running the fund, because they know venture capital. . . . [But] you want to be sure they're roughly in line with government expectations," he says.

In an effort to keep the lines of communication open, In-Q-Tel's charter established a center at CIA headquarters where the fund managers and agency officials talk about what they're both working on and how to get the new technology to the intelligence community. The Army gives OnPoint a "technology roadmap" so the fund bases investments on the service's long-term goals. Also, part of the OnPoint management team's compensation is based on whether technology gets used by the Army. (Maitland, Fla.-based venture company MILCOM Technologies Inc. manages OnPoint.)

Spokeswoman Melissa Mathews says NASA's goal with its venture capital fund, Red Planet Capital, is not only to support emerging technologies, but also to "help NASA gain access to partners that don't traditionally do business with the government and possibly influence product development." Red Planet Capital will be looking to support technologies that will help NASA on its space missions, including those than can improve water recycling, communications, biomedical support, and human or machine interaction. NASA has set aside $11 million in fiscal 2006 and anticipates allocating $20 million annually to the fund. Like the CIA and the Army, NASA expects its fund to be profitable. Profits are pumped back into their investment reserves.

Companies are happy to take the cash and government relationships that come with it. "The ability to have them help us work through a lot of the political channels to ensure that we're getting to the right people, and not wasting our time with some of the others, ends up allowing us to have a much lower overhead organization," says Gary Davison, president, chief executive officer and co-founder of PowerPrecise. Without that help, companies like his tend to be "a bit squeamish about doing business with the government," Davison adds.

"It's very much what we call a strategic investment. It's not only the capital, but a Rolodex of key contacts throughout the military," says Ross Dueber, president and CEO of Zinc Matrix Power Inc., a Camarillo, Calif.-based company that received an investment from OnPoint in October 2004 and is developing a rechargeable battery based on silver zinc for military use.

In-Q-Tel and OnPoint usually collaborate with other venture capital funds; Rottenberg and Tighe say their funds leverage $8 from the private sector for every $1 they invest. As a result, many venture capitalists welcome the federal involvement and say they see the funds as partners rather than competitors.

Some fear funds that get their money from government face the added risk of becoming politicized. "The thing I most worry about . . . is that [federally funded venture capital management] will become a political process," says Mark Cannon, a venture capitalist and former fellow at the National Academy of Public Administration. "At least you know the private venture capitalists are looking for a competitive, well-managed program that is expected to be profitable. They may have some other influences, but they're marginal."

Chris Foster, deputy secretary of Maryland's Department of Business and Economic Development, which manages the $6.5 million Maryland Venture Fund, says he runs interference when state legislators try to influence decisions, and the fund has a strict policy against such pressure.

Many states start venture capital funds to bolster their local economies, but only the funds financed at the federal level attempt to identify and invest in future government contractors.

Seed Money

The Army and the CIA manage venture capital funds that invest in developing technology. Here's a breakdown of their activities.

Army

• Battery charge measurement technology for portable field batteries (PowerPrecise Solutions)
• Higher power density fuel cell system based on generating hydrogen from highly concentrated methanol for use in portable electronics (UltraCell)
• Advanced rechargeable batteries based on silver zinc (Zinc Matrix Power)
• Thin-film solar technology (Nanosolar)

CIA

• Secure information sharing technology (Initiate Systems)
• Bipolar rechargeable lithium batteries (Electro Energy)
• Wireless networking (Tendril Networks, Dust Networks and others)
• Sophisticated user interface for viewing maps, video, Web and other content (Idelix Software)