"Small businesses comprise more than seventy percent of the companies that do business with the Department. If the Department does not work to reverse the decline of small business contracting, then the industrial base that equips our military will weaken."
Secretary of Defense Lloyd Austin
Department of Defense Small Business Strategy
Investment Thesis
Building the next generation of government technology and services firms
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Executive Summary:
Government contractors are integral to national defense and all government functions, providing over $700 billion worth of products and services annually. Small businesses contribute over $150 billion of this total. Despite growing budgets, contractor numbers have declined by 50% over the past 12 years to 60,000 today. To uphold our defense and global leadership, continuous investment in technology and private sector innovation is essential. We see an opportunity to develop new services firms in rapidly growing capability areas and tap into the deep pool of entrepreneurial talent among the 2 million people in the contracting workforce. We support these entrepreneurs with capital and expertise to build the next generation of government technology and services firms.
Background:
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The U.S. government, the world's largest customer, spends hundreds of billions annually on procurement. From nuclear engineering to facilities support, private sector collaboration is essential to governmental missions. Over the past decades the government contracting sector has continued to grow in size and share of total government budget and workforce. In addition to supporting defense and national security domains, government contractors contribute greatly to America’s science, healthcare, education, energy, transportation, infrastructure and more.
Our defense ecosystem has a long and successful history of employing private sector innovation to create and deploy essential technologies. Innovations developed initially for government use have become foundational technologies within our economy – giving rise to Silicon Valley, the internet, GPS, and more. This public-private approach is a uniquely American success story.
In the 21st century, the private sector has accelerated its pace of innovation, leading heavy investments in cutting edge areas such as AI, cloud computing, and autonomous systems. For the US to maintain its leadership in this era of Great Power Competition, it must successfully utilize the best technologies and resources from our private sector.
​Small businesses' critical role:
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Small businesses, responsible for over $150 billion of government contract work, excel in speed, agility and innovation. Working synergistically with large primes and their government and military partners, they provide resilience, efficiency and competition.
To compete successfully, small contractors must bring unique value to their government customers and project teams. New contractors take time and capital to grow: building a history of successful past performance, navigating a complex regulatory environment, and recruiting talent are long term initiatives. Unfortunately, many small businesses lack the capital, expertise, strategy or endurance to successfully scale.
Shrinking contractor base:
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The number of federal contracting has shrunk dramatically: from 120,000 in 2010 to 60,000 today. This decline can be attributed to regulatory complexities, industry consolidation, ownership restrictions, and the appeal of the robust private sector attracting entrepreneurs and engineers. Many small business contractors lack a coherent strategy or capability focus, fail to scale, and are faced with unattractive exit opportunities.
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Entrepreneurs Needed
Of the 14,000 firms that generated over $1M of contracting revenue with the federal government last year, less than 1,000 of them (7%) were founded within the past 3 years.
Challenges for emerging services firms to access capital:
Sector-specific challenges such as contract concentration, limited visibility due to security concerns, and a complex regulatory environment often deter generalist investors. Specialist firms have led the sector’s investment growth.
Private equity firms have had great success and made significant contributions to the government contracting market. By virtue of fund size, holding periods, and small business affiliation concerns, most sector-focused PE funds invest in larger buyouts, targeting firms with over $50M in annual revenue. Smaller contractors can be targets for add-on acquisitions.
Venture capital in the sector primarily focuses on firms developing new products, rather than the firms delivering the integration and support services. We are pleased to see more venture capital turning towards the defense tech market, as well as the public-private programs encouraging it.
Lenders can help emerging contractors access working capital and fund growth once there is enough work to underwrite. Understandably, few lenders are interested in taking risk at the earliest stages when equity financing is more appropriate.
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Our Investment Strategy:
We see a large, specialized industry with a shrinking supply of contractors, a growing demand for leading technical capabilities, asset-light business models, and an undercapitalized talent pool of potential entrepreneurs. We believe this is an excellent dynamic for early stage investing with patient capital and strategic support.
1. Seed Capital: We invest seed capital to launch new government technology and services firms. Within the talent pool of 2 million federal contractor employees, we believe there is an untapped cadre of entrepreneurs. We help empower these entrepreneurs to become owners and CEOs of their own firms, supporting them with long-term capital and strategic assistance where needed. We are minority, non-control investors. We invest our own capital, with no pre-defined holding period.
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2. Growth Equity: We invest growth equity in emerging contractors. We will offer targeted investments to emerging small business government contractors at critical inflection points, providing the capital and support needed to grow them into mid-sized or large prime contractors.
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Target business models and areas of focus:
We focus primarily on asset-light services firms. These firms support critical functions such as IT modernization, R&D, engineering, analysis, program management, software development, test & evaluation, facility operations, training, simulation, and more.
We target capabilities and end markets that require specialized knowledge and have strong growth potential. Areas of interest include AI, cybersecurity, IT modernization, unmanned systems, space systems, and critical infrastructure support. Insights from government leaders, program budgets, industry days, and interactions with large primes guide our targeting.
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Our Why:
We are committed to strengthening national defense, ensuring technological supremacy, and upholding America's global leadership. A robust defense industrial base is essential for national security, and we believe in empowering entrepreneurs as a significant contribution to this goal.
Interested in learning more? Reach out.
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