Mobilizing Private Capital on Aligning Private Investment with DoD Needs

Speaker A: Foreign. Welcome to the Emerging Tech Horizons podcast. I'm Arun Serafin, executive director of NDIA's Emerging Technologies Institute. Today we're going to talk about the flow of private capital into the defense sector and how it's reshaping the entire defense industrial base. Uh, as we all know, billions of dollars in capital are flowing from sources like venture capital and private equity and other sources like angel investors into all levels of the defense industrial base. And companies like Palantir and Anduril, which are both great NDIA members, are benefiting greatly with these additional resources. Every day, increasing numbers of investors are looking at those big firms and in small firms throughout the defense industrial base for opportunities attracted by the potential of grabbing a share of growing U.S. and global defense budgets. At the same time, the Pentagon is actively working with these kinds of investors and the companies they're investing in to entertain their entry into the defense industrial base. And Congress has joined on as well, looking at old authorities, fixing them up, creating new authorities, all to streamline how private capital can move dollars into those industries to create the products that we need for our war fighters at new speeds. All of this activity, though, raises questions about the future. What's the viability of all this investment and the returns? Are we in some kind of a bubble with this kind of defense investment? What are the downside risks of this money flowing into the defense sector? And then on the more positive side, how can we help shepherd all of this new money to build the industrial and innovation base of the future that we all want to achieve? To discuss all of this today, I'm joined by Sam Moyer, my colleague and a research fellow here at eti. Sam's been with us about a year and a half, but this is the first time you're coming onto the podcast. This is great. Sam is an author of multiple papers and articles on this topic, and including more recently, a paper called Mobilizing Private Capital for Defense, which talks about how the private capital sector is interacting more and more with the defense sector. And then a paper he published as part of the Naval Postgraduate School's Acquisition Research Symposium called A Strategic Federal Equity Investing Approaches to Advance National Security. That's on top of articles and short courses in previous work that Sam's done in in the field. So to join us in this conversation, uh, I'm pleased to have Sam Moyer welcome. Sam, good morning.

Speaker B: Great to be here.

Speaker A: So, to level set for our listeners, let's just set a baseline. Can you just go through and explain some of the terms of art that we need to be understanding if we're thinking about private capital and its interaction with national security. So, for example, what does private capital mean and what are some of the recent trends that we're seeing?

Speaker B: Yeah, absolutely. Private capital is a term that can have different meanings depending on what audience is using it and hearing it. Uh, what it generally refers to is, in the context of our research that we're interested in here at eti, is capital that's being invested in the defense industrial base or innovation base that's not coming from the public sector, from the federal government. And where does that money come from? Well, it depends on the kind of company you're talking about. If you're a small business or a startup, you might be accessing private capital from venture capitalists, uh, or an alternative lending investor, uh, like receivables financing company. Um, if you are a large defense contractor, you may have retained earnings on your balance sheet that you can use to invest in capital expenditures or R and D. Uh, and so the large defense contractors, many of them are publicly traded. They're using the capital that they're able to access as large companies and from their profits that they retain to invest in their own capabilities and grow. Another large market is what they call the private equity or private credit markets. These are large, uh, investment firms that will typically acquire companies, uh, add them to their portfolios, and that money can often be used to help grow the company. Uh, and so what you end up with is really a wide range of different types of capital that's active in the defense sector. Each type of capital has a different purpose. It tends to be interested in different kinds of companies doing different things with the money. What it all has in common is it's seeking return. It wants to make sure that the money doesn't get lost and ideally provides some kind of, uh, return to, to the investor who invested it. Uh, to your question about trends, this is a topic, as you mentioned your opening, that is getting a lot more interest right now from the public, uh, from leadership in the Defense Department and throughout the federal government, from Congress. This idea of how can we get more investment to flow into the defense sector. And so we took a look in the, in the report you mentioned mobilizing private capital for defense at the amount of money that's flowing in from each of those different, uh, types of capital I talked about. Often they're called asset classes. And what I found is that the amount of capital that's invested is quite large when you compare it to how much the Pentagon spends on, on acquisitions. For example, each year it ends up being something like $90 billion a year over the past couple years on average. Um, and that's, uh, flowing, as I said, from, from many asset classes. It's not comprehensive. It's very hard to get an exact figure on how much is invested because most private capital investments are private transactions, and so they're not necessarily publicly announcing every time a private equity firm buys a company. Um, the other thing we noticed is that there is definitely an upward trend in terms of how much capital is being invested. But at the same time, it's not what I would necessarily describe as a huge surge in investment. I think my takeaway from looking at the numbers is for a long time, the defense sector has been very active, very vibrant, and there's been quite a lot of private capital that's been invested. So while there's, uh, a lot of excitement that's justified in the capital that's flowing into the sector, especially at a venture which venture capital has shown quite a clear, uh, upward trend. At the same time, I think that's against a broadly positive picture, which is that the defense sector is quite vibrant from an investment standpoint.

Speaker A: When you talk about the amount of money that's going into the sector now, roughly speaking, you said, is it $90 billion a year? Ish.

Speaker B: Yeah, roughly 90 billion. And as I said, if you, uh, want to get nerdy with the data, you can start looking at the specific sources, uh, of that data, and you can. What you start to find is that most of those, uh, most of those data points are probably an undercount. I have a nice appendix if you're into that kind of thing, in the Mobilizing Private Capital report where I calculated these things. So you run into questions, for example, like if a venture capital firm invests in an AI company that's creating great AI in America, but it's not necessarily just targeting defense. Does that count as a defense sector investment? Well, the data set that we use from Pitchbook, it says generally, yes, there's a discretionary component. Right? What do we count as defense, dual use or fully commercial? Um, other people can look at the same data, squint their eyes, and maybe see something slightly different. So you can. There's a bit of a margin of error with that $90 billion number, but I think it's directionally correct. And the trend line going upward is also directionally correct.

Speaker A: $90 billion is still less than the annual budget request and appropriation for research, development, test and evaluation, which is in the 100 to $200 billion range annually. So it's less than that. It's certainly less than the trillion and a half dollars that we're talking about potentially flowing into the system for fiscal year 2027. But apparently it's causing a big stir. So this roughly 90 ish billion dollars, what kinds of things is it being invested in? Should I think of it as R and D money? Should I think of it as basic research money? Or are they investing in procurement of items? What kinds of things are they investing?

Speaker B: Yeah, it's really a mix. I think one way to think about it is if you're a small, um, business, say or a large business and you have investment dollars, what are you doing with those investment dollars? And there's a couple of categories that you can think of from kind of a, uh, financial analysis angle. So one would be what they call capex capital expenditures. And, and what that means is that a lot of companies have to build factories or they have to buy equipment or uh, they have to buy real estate to put their people into. That would all count under capital expenditures. Uh, R and D you mentioned. So that's scientific research, uh, trying to develop new innovations and patent them. Um, that's something that we see especially when we look at the defense primes. But most venture capital dollars tend to go towards early stage companies that are doing something that we might recognize as R and D. Another thing though is working capital. So if you need to survive month to month, uh, you need a certain amount of liquidity they call it, uh, on your balance sheet. So you need to have basically a checking account and you need money in there to carry so that you can pay your workers and you can survive month to month. Companies need a lot of working capital, uh, especially in the defense sector where there's long lead times. And so a lot of the capital, uh, across all these asset classes is used for things like working capital.

Speaker A: So with that as some framing, let's talk about this report which is available on the ETI website. Tell us why you took on this report. What were the big questions and what you found?

Speaker B: Well, as to why, I think it's really the themes that we already hit on. This is something that a lot of folks in the public sector are getting more interested in. As you said, traditionally it's not something that public servants think a lot about. Even in the acquisitions community. Uh, it tends to be treated in the way the American acquisitions, uh, function works. How a company raises capital tends to be thought of as something that, that's the company's business and it's not necessarily something that the government acquisition system is interested in. Well, that's all changed now. There's a real interest in what is the vibrancy of the defense industrial base in terms of financial viability and the amount invested. So we wanted to first of all just get an assessment of how much capital is being invested, uh, and take a look at that. Um, after we did that, we started realizing there's really an opportunity here to make some policy recommendations. Uh, we interviewed a lot of small, uh, businesses, startups, also large businesses and folks in the investment community and they made a lot of observations about, in their particular investment arena, what are the pain points that they have, uh, and also what are the unique tactics that they've seen that leads to success in terms of helping a company become viable to raise private capital and make investment in the defense industrial base. So all that wisdom accumulated and we really wanted to find an opportunity to publish it out, get it out there and start a dialogue.

Speaker A: What was the methodology used to go after some of these questions?

Speaker B: It was really interview based. Uh, because we're part of a, uh, trade association, we have a really, uh, I think a unique ability to talk to folks in lots of different parts of the defense industrial base. We can go talk to people in government who think about acquisitions or in leadership positions and we can go talk to large defense contractors, small ones, non traditionals, um, as well as investors. We have many investors who like to come to our events and engage with us. So we were able to look at a broad swath of the community that thinks about these things and get different points of view.

Speaker A: And then there's data as well. Right, you mentioned Pitchbook for example. But I'm imagining there's contract data that uh, you can see is going to these companies that are receiving this money. There's even forms of money coming straight from the government. Right, so. And all of that data then factored into the report as well?

Speaker B: Yeah, that's right. We didn't take too close of a look at acquisitions data and award data, other than to look at specific companies and how successful they have been in transitioning. Uh, but there are like you said, many really unique data sets that look at different segments of the investment community and how much they're investing.

Speaker A: So what'd you find?

Speaker B: Well, what we found, uh, in terms of tactics is that there are a range of things that, if you think about it from, um, an acquisition point of view that the department can do to make it more likely that a firm is able to access financial Services or invest money in growth. And those tactics, there's a whole lot of different tactics. We heard, right? We would talk to one company and ask them, what can the government do to make you more likely to invest? And that they'd say something really interesting. We talked to another company, they'd say something completely different. So what we really realized is that we needed to have a taxonomy. You and I, I think we debated this as, as I was. As I was, uh, writing up the report. Um, and what we decided is there's three broad buckets that these tactics seem to fall into. Bucket one is what you would call demand signal. Anybody who's worked at all in government acquisitions, um, has heard this term, right? It's another way of saying companies and investors want to see a return on investment. They need to make some kind of money. Otherwise, why would you invest? I think that's intuitive for everyone. Now, how can the government show Demand Signal? That's where it gets interesting. There's a lot of different ways. And so we cataloged the different ones that companies and investors seemed to think were important. Um, and, uh, I'll give a couple examples in a moment, but I'll run through the taxonomy first. So demand signal was one. Number two is what we call catalytic capital. And this is the tactic whereby the government can actually do things where it can directly incentivize a company financially to raise capital or to invest. These are things like Office of Strategic Capital Loans, um, but there are many others. And then the last one is this concept of the business environment. And anyone who's familiar with the literature on investment across the economy knows that that business environment, it's one of these ineffable things, but it has a huge impact on what the appetite for investment is in the investment community. If you have an investment environment that is perceived by the investment community as stable and, uh, legible, something they can understand and engage with, they're more likely to invest. But the opposite thing can happen if your business environment is perceived as confusing or risky, Then even if there's a strong investment opportunity, investors still might be deterred. Uh, so we can walk through each of those categories if you'd like, but each one, what we found is there are a number of opportunities that the government can either build on success or try to pilot new things.

Speaker A: Let's focus on this issue of demand signaling. So I guess that means showing investors that there is money to be made in this defense sector by showing them kind of like what they would see in a commercial market. The size of the Market, the timing of the market, um, and maybe even some of those more climactic kinds of things. Right? How easy a place is this to work in and make some money? So what did you find were the most interesting mechanisms to send that demand signal? And why aren't we doing these things if they are interesting and good ways of sending demand signals?

Speaker B: Yeah, well, the first thing to say is that the government does send a lot of demand signals already. You know this better than anyone, right? Congress really sets the overall tone because Congress appropriates dollars, and which is where the unauthorized programs and those are the two things that actually allow somebody from government to buy something from industry. And so really that's the most important part. And the rest of it is how can DoD communicate that demand, uh, more effectively to the investment community? Uh, something else that you probably are aware of if you've spent any time in defense contracting is the government can be kind of a confusing customer. And, and for folks who are very familiar with that market, that might not be such a big deal. They know where to look, they know how to look up R1s and budget appropriations, um, appropriations tables and so on. But many investors who are interested in defense don't know any of that. So simple things like by providing venues where investors can interact with government and companies as well who are investing their own capital can interact with government. It seems like a small thing, but that communication can often clarify something that makes a demand signal a lot more plausible to a company or an investor. And remember a lot of times what happens to facilitate an investment is a company sees something the government says, they put that into a pitch deck or a loan application, and then they show it to an investor. So what we have to do is, um, we have to make sure that the department is able to give companies the information they need to make their case as a strong investment to the investment community. Now, there's a, ah, whole range of tactics here. So on one end there's, well, what I would describe as rhetoric or writing reports. Folks from the department can give speeches, can give speeches, but those speeches can be quite valuable because if you're a senior leader and you have a roadmap for developing a product, a company might see that roadmap and realize that they're right at the center of it and that makes them potentially investable. Um, now there's a whole spectrum that goes all the way to what I would describe as much the other end in terms of how strong that commitment is, the rhetoric is on one end, there's no guarantee just because someone says a speech, you're going to win a contract. On the other hand, there's some quite strong demand signals that the department can send. These are things like offtake agreements, purchase guarantees.

Speaker A: What are offtake agreements?

Speaker B: Offtake agreements are a family of acquisition tools that uh, they're very common in the private sector, less so in the public sector. They're basically a long term purchase commitment. So government tends to like to buy things in increments of one or two years. In the private sector you might see companies agreeing to buy 10 years of a supply of something from a company. And well, if a company has 10 year purchase commitment and they need to make an investment, they can take that to the bank and say, you know, guess what, I have almost close to guaranteed revenue stream. So it turns out DOD does have uh, authorities to do things like that in certain circumstances. And, and uh, even has done things like that in circumstances, certain circumstances, quite unusual. And in between those two, those two poles you have things that are somewhere in between. An example might be, ah, a memorandum of understanding that a program office could sign that would say something like we intend to buy this from you, uh, at X date. It's non binding, but it is a stronger demand signal than rhetoric, maybe not as strong as an offtake agreement. So there's a whole bunch of shades of gray in between those two. And uh, DOD has used them quite effectively over time.

Speaker A: Those demand signals, one have to be legal with respect to how government dollars are budgeted for and appropriated. Is there anything about demand signaling which requires a change to that kind of financial management issue so that the department can send signals like the private sector does?

Speaker B: Well it's a case by case basis. So an offtake agreement, for example, the strongest of demand signals to really sign a plausible credible offtake agreement, let's say for 10 years for buying magnets, maybe from a magnet production company. Um, to do that the government would have to have dollars, know your dollars or dollars that, that are, that are valid out for 10 years, which is unusual. That's a special type of appropriation from Congress. And it would also have to have the authority to sign a contract that can last for 10 years. So those are two unique things, uh, that you have to have to make that a credible, uh, a credible agreement. Now both of those things happen and have happened, uh, but they are unusual. And so um, in each instance that you would like to see that kind of tool used, you would have to have that kind of authority from Congress.

Speaker A: And is the demand signaling that you're talking about in this report different than the kind of demand signaling that's expected from the traditional defense industrial base. So when I think about the traditional systems integrators and their subcontractors and those people selling services to the department right now, are they happy with the demand signals they're getting? They seem to be doing okay. What would they do with these new demand signals?

Speaker B: Yeah, I think that, um, from what I heard in interviews, everybody seems to want stronger demand signals. Um, and so if there are, if there are opportunities for the government to, to provide those kinds of demand signals, I think industry would be quite happy in general. Can't hurt. Right? But as you said, industry is able to invest. Right? We saw it in the data. There's quite a lot of investment happening. The vast majority of that investment has nothing to do with offtake agreements or the, or the very other very strong demand signals that we talked about. Most of them are part of the normal course of government acquisitions. And by the way, if you look in the commercial sector, most companies are not getting offtake agreements. Right. When McDonald's sells me a Big Mac, it's not because they have an offtake agreement with me that was signed 10 years ago. So companies are able to invest. They don't need perfection in terms of demand signal. But at the same time, if you know that you're going to need something over 10 years, uh, why not sign an offtake agreement and enable that company to raise cheaper, uh, capital and make an investment today? So in certain circumstances, it makes a lot of sense.

Speaker A: There's another kind of investment that the government is making right now which moves past the demand signals and actual, I think, spending of money, which you covered in your Naval Postgraduate School report that I want to talk about for a second. That's equity investments. Um, we've seen the federal government announce equity investments in companies like intel and now a set of quantum computing companies as well. So let's talk about that for a second. First, what is an equity investment and what does it mean for the company? What does it mean for the taxpayer?

Speaker B: Yeah, yeah, this is a really interesting one and probably one of the more exotic concepts, uh, that we've seen lately. Equity. As many of our listeners probably know intuitively, it's what you buy in your 401k, uh, on the public markets from a, from the NASDAQ or, or a, uh, New York Stock Exchange. You can buy equity in Apple Corporation, and then there's private equity. So equity you can buy on an exchange, and that's what venture capitalists and private equity companies buy, uh, in unlisted companies, ultimately there are different flavors of the same thing, which is owning a piece of a company which gives you ownership of any, what they call residual claims or future profits. It turns out equity is a little more complicated than that. So financial returns are probably the most important thing to know about equity. But interestingly, equity really involves what you might call a bundle of rights and obligations between the you, the shareholder and the company. So many people might know that if you own equity, you also have some sort of control rights over a company. And that can vary depending on the way the equity agreement is structured. But it might mean that you have the ability to have a board member on the board of directors that could be you. It might mean that you have the right to vote in board elections and elect a board member that that's someone else. It might mean that when there are certain kinds of decisions made by the company, strategic decisions like whether or not to sell the company in an acquisition, that you get the right to vote in that decision. Um, and then there's another type of control right which isn't exercised through voting. And that's called covenants. And what a covenant is, is it'll be part of an equity agreement and it'll say something like the company is not allowed to do XYZ or the company must do xyz. An example of that might be the company has to maintain a certain standard of cybersecurity. So there's a whole bundle of rights that are negotiable for every equity transaction. Um, now why is this interesting from the standpoint of public policy? Well, as it turns out, there are certain kinds of investments that are not really that well suited to debt or grants or other acquisition tools. And these tend to be, number one, very, very large investments. So maybe a quantum company is trying to build uh, a new, uh, fab to turn out chips that might cost hundreds of millions or a billion dollars. Uh, that's a lot of money to just give a, money, give a company in a grant. Uh, and another interesting aspect is that sometimes debt is not a very good tool for dealing with those things either because they're highly, highly risky. And debt as a tool, and this has just been shown in the academic literature and economics, it's not really good at handling high risk scenarios because you can only crank up the interest rate so much to compensate for that. And so it's really not feasible for debt investors to take 50% in interest rate. So equity just turns out to be the right tool for Certain kinds of investments. Um, and so there are scenarios where the government has started looking at using direct, uh, equity investments as an acquisition tool. And I'm sure we'll talk a little about the risks. But the flip side of equity is all of those rights and obligations I was talking about, they're so flexible and so powerful. Uh, that can be really useful from an acquisition standpoint, but it can also be quite, uh, risky because that hands a lot of control over the government acquisition community that's running it. Uh, and so that just means it's a lot harder to run compliance and

Speaker A: controls against this new round of equity investments that we're hearing about today. How different are they than what we used to talk about and still goes on from a place like in qtel?

Speaker B: Well, I, uh, would say that in terms of equity investments, they're going to be basically the same thing. Um, it's the same tool. That being said, the way that Inkitel is run, as I understand it, and I'm not an expert in Icutel, um, and the way OnPoint was run, which was an army program, uh, I believe they were pretty similar in the sense that they were what I would describe as a hands off arrangement. The investments were run through a nonprofit entity and the nonprofit enemy was set up or in Qitel is set up to be basically a standalone organization that's similar to private investment firms like venture capitalists. Uh, and the government then becomes an investor in that company. What we've seen lately in things like the, the uh, the quantum investments and then a couple other DOD investments like one in Mountain Pass Materials, uh, a mining and refining company, is the government taking direct stake in companies itself. And so there isn't that hands off relationship. And that means that the government, the government personnel, acquisitions personnel, they're the ones who are in charge of selecting the companies. And then if there's any kind of control mechanism like a board seat actually taking part in that activity as well.

Speaker A: Yeah, it sounds very complicated. And when I think about all the work that's been done over the decades on acquisition reform and waste fraud and abuse and ensuring the rights of taxpayers, um, these things sound very interesting. Interesting. Potentially have a lot of upside, but dangerous. Right. The, the idea that we're smart enough to make these kinds of investments and understand the rates of return, how an investment in a company who we're then going to have to buy things from interacts with the traditional acquisition process and the fairness that we want in that acquisition process, I think that all I guess is still needs to be sorted out, right?

Speaker B: Yeah, absolutely. It's probably beyond the scope of this discussion because there are so many interesting questions one could ask, right, about how does an equity transaction compare to, uh, a traditional acquisition? Um, what kind of fairness rules apply? Um, the good news is that equity is something that's done all the time in the private sector and also has been done in the public sector. So there are good lessons learned we can draw from in terms of how to make sure these transactions are done at a high level of quality and how we run compliance for them, and so on and so forth. But because they're so unique, uh, and new for the defense acquisition system. Yeah, I think there's a lot of opportunity to study exactly how that will unfold in that setting.

Speaker A: All right, let's drill down a little bit on some of these potential downsides. The, the idea that, um, private sector companies are going to receive money from a combination of private capital investors and the governments, um, and c, making use of some of the new tools of acquisition reform, maybe more almost guaranteed returns or expected guarantees of return. Um, all of that creates some tension. Uh, how did you, in these reports, in your other work, look at the potential downsides and what we can do to mitigate them?

Speaker B: Well, we took a look at, uh, different scenarios where, uh, downsides were made manifest. So scenarios where private investment, um, was involved in misappropriation of public resources, uh, and other things like that. I would say what we found is that in a sense, um, the same procurement integrity questions and norms that apply to any kind of federal support also apply when private capital is at play. So I think we have a strong set of frameworks in the Defense Department in terms of how to control these things, how to make sure, for example, that companies are selected based on the merit of their solution rather than who's on, uh, their board of directors or who's invested in that company or if

Speaker A: the government has a stake in that company.

Speaker B: Yeah, yeah, I think. Absolutely. So I, uh, think we have those strong frameworks in place, and it's just a matter of applying them potentially for companies that are raising a lot of capital.

Speaker A: How is the workforce that's making these investment decisions being trained? What do we feel like is their knowledge of the potential returns here, the speeds of returns that are expected? They're giving out loans now, they're making equity investments, they're making these sort of VC style investments. Right. So, uh, who's the workforce that's doing this?

Speaker B: I would separate the group that's doing the equity investments. Ah, as well as the debt investments, that's the Office of Strategic Capital. I would put them in one category. And then in another category I might put government personnel who are just working with companies that are investor backed. Um, for that second category, I don't think you need to have any special knowledge to work with uh, a non traditional company that's venture backed versus maybe a more traditional system integrator. Both of them are investing a lot of capital. Both of them want to make returns on investment. Both of them are competing based on the strength of their solutions. So I think that's fairly standard from an acquisitions point of view. In that first category, the government self engaging in what you might call more exotic industrial policy tools, uh, Office of Strategic Capital, issuing direct loans to companies, loan guarantees, uh, title $3 being used for equity investments. That is something that you really want someone who is very well versed in those tools.

Speaker A: So these aren't traditional contracting officers.

Speaker B: Exactly. And that's really what we've seen. We've seen the department forming um, a group of uh, what they call the economic warfare unit or the Economic Defense Unit, um, trying to create a cell of investors who come out of the investment industry and they know what it's like to evaluate a company to see is the share price that's being asked fair, what should control mechanisms should be in place, what kind of covenants should I ask for all those complicated questions that aren't part of a normal defense acquisition personnel, uh, person's uh, education. You really need people who are experienced, uh, in industry to run those things.

Speaker A: This system is intended to bring in more private capital money and therefore I suppose fund a new set of companies, maybe small companies. Is it becoming simple enough for small companies to understand what's going on here? Or have we made the system even more complicated than it was before?

Speaker B: We're still at uh, what I would describe as an early era in terms of using those catalytic uh, capital tools that I was describing. So your debt, your loan guarantees, your equity, those still have not been used very much. Those tools are all housed at the OSD level. Uh, they're not involved in the services and program offices or PAEs or anything like that. So what we've seen is a fairly small number, something like eight to ten of these deals. Uh, so we're at a very early stage. I think that split between the services, where most of the acquisition dollars are, procurement dollars are, uh, and sustainment versus osd, which is where these tools and authorities are, making sure those things are orchestrated is going to be a Big challenge and opportunity. And that's what's going to determine how accessible this is for your average small business who might not know how to apply to those programs.

Speaker A: When I think about the interaction of these kinds of funds with traditional acquisition law and the safeguards that are put into traditional acquisition law, like the Competition and Contracting act, um, are we working towards a level of transparency and fairness in the use of those instruments?

Speaker B: I think that's in Congress's hands. From what I've seen, Congress is really interested in these things. Congresses, they're the ones that, that gave offices to each capital, all of its, uh, all of its capital that can, that it can use. Um, they're the ones that have, uh, provided title, increased amounts of title, $3. So I think Congress is very engaged. Um, and, and from what I've seen, the, the provisions that have been provided are pretty thoughtful in terms of the control mechanisms. I guess I would maybe turn this question around to you. Uh, if you were back in your chair in the Armed Services Committee, uh, what would you be thinking about? And, uh, um, would you be. How would you be approaching, uh, monitoring these things and then potentially providing controls over time?

Speaker A: And I guess I would be thinking about the use of these dollars, which they have to be appropriated to the government for, then. The government, the Pentagon, to use them in either equity investments or loan guarantees or whatever style of investment, just like they would for a contract or a grant. So I'd want some transparency to the potential recipients to ensure there is a fair level playing field for people who want to apply to get access to some of this money. And then I'd want some ability to understand the returns that the taxpayer is seeing and the war fighter is seeing from some of these investments. Those structures are put into place on the acquisition side. Um, you also want to make sure there's some kind of control mechanisms in place to watch over and help the workforce on the executive branch side make investments that are not going to look like the taxpayers being ripped off. That combination of oversight things does create baggage sometimes, which slows down systems and frustrates people trying to enter the defense sector. But if you don't have those things in place, maybe you're not doing the best work for the taxpayer. So I would be thinking about things in those ways and trying to make sure there are some mechanisms without sacrificing speed and flexibility to make sure the taxpayer is not getting ripped off.

Speaker B: Yeah, I think that's totally reasonable. I mean, even a, a private sector investment firm, it has an investment committee that's in charge of having auditable records that show how each investment decision was made. Uh, it has shareholders. In the case of a venture firm, it might be limited partners who are reviewing the returns that they get. And they get to have meetings with the, the, the, uh, the managers of the fund and ask questions and provide oversight. And you know, they themselves have, have certain levels of control, uh, over what the fund does because they own the fund, there are shareholders in the fund. So I think what you're describing, in my opinion is totally reasonable. And there's no reason that you can't have that kind of, uh, oversight and transparency as well as monitoring returns to see if they're healthy. Um, too. So, uh, I suppose it's all about the execution. Um, but I think in terms of a framework it makes perfect sense.

Speaker A: And we're still in early days for a lot of this. Okay, so assuming this kind of works out in the way that the private capital investors wanted to and those government investors wanted to, then what happens now? What does the future then look like? And why would you say that it's better than where we are today?

Speaker B: Well, let's set aside equity because equity is I think, an exotic enough, a new enough tool and different enough tool that I put that in a different category. That's m. Something that's, that needs to be dealt with very carefully, uh, and probably is a highly specialized tool that shouldn't become mainstream, uh, even if it's worth exploring. But in terms of things like showing demand signal and providing catalytic capital of other kinds and a strong business environment, in my opinion that's just common sense and it's what the department tries to do anyway. Uh, and uh, so what does a vision for the future look like? Having more awareness in the acquisition community of how decisions that are made throughout the acquisition process can do things like destroy demand signal or create demand signal that leads to investment or deters investment. How can we in the acquisition community collaborate with some of those catalytic capital programs that are in the OSD level, be aware of them and understand when to engage them and who to go talk to? Maybe if I think that I'm working with a company that would benefit from receiving a loan or other kind of catalytic capital, uh, those kinds of things which we talk about in the paper I, uh, think could lead to a stronger, more vibrant, uh, investment environment, more investment in the defense industrial base, more dual use companies who are interested in coming in, uh, and selling to the government, uh, because there's already a healthy amount of capital that's being Invested. I don't imagine that there's going to be some kind of transformational flow where we see it go from $90 billion a year to $1 trillion a year. Because the, like you said, the, the, the budget of the Defense Department is fairly fixed. It can go up a bit, but, um, it's not going to triple. Right. So there's going to be a correlation between how much, how much stuff the Pentagon is buying and how much investment goes in. I think we can see an increase in the amount of private capital that's used and potentially more efficient use of that capital. If the investment community and the companies that are investing really can understand their government buyer and work hand in hand.

Speaker A: Do you think that investors on the private side are going to be surprised by the returns they see over the next 10 years because they're too small or surprised at how big they are? What's, what's. How should we be thinking about the returns on all of these investments?

Speaker B: I don't know the answer to this question because you'd have to get in the head of the investors and what they imagine, um, the government spends a lot of money on defense products. So there will be winners. There will be companies that get big contracts and that grow. There will be M and A activity, mergers and acquisitions, where a company that has something useful but maybe didn't grow as fast as the investors liked, maybe it's sold to one of the primes or to another company or maybe there's a merger. These things are all normal in any industry. So I don't expect a big crash or, uh. Um, I don't, I don't. I think what we're seeing is fairly normal and fairly healthy in any industry. Um, but you never know. There could be what they call the Gartner hype cycle, where people are, are too optimistic and then there's a lot of disappointment. And that leads to, um, and that could lead to stress in the industry. Um, but I don't think that this industry is that much different than other industries in terms of the level of excitement and the amount of capital being invested.

Speaker A: There are some fixed objects in the defense acquisition and innovation world, namely the government laboratories, the university community, the systems integrators, the traditional defense primes. How do they get affected by all of this private capital money coming in and these new kinds of investment styles coming out of the government?

Speaker B: Well, I should say very clearly that the large systems integrators, they are one of the largest sources of private capital in the dip. So everything I've Been saying about investors and companies, these companies are investors in the dip. They're some of the largest investors. So uh, if you look at their stock prices, they've gone up lately in line with the overall uh, optimism about this sector. So I think that the systems integrators and small businesses too for that matter, uh, they ought to be able to have uh, better access to financial services and they ought to be um, uh, they are making, increasing the amount of investment they're making in the dim, the way venture capital is. Um, now other parts of the defense industrial base, I agree with you, they're important and they're useful. Um, I suppose it's a case by case basis but what I've observed is a lot of venture backed companies are partnered with defense labs, um, and uh, uh, other parts of this community. And so I think that that's another way that what we're seeing right now is not so different than the way that the ecosystem has operated for a long time.

Speaker A: I think that this money flowing in from the private capital world is creating another opportunity to take intellectual property that's being created in universities and government labs, potentially mature it and then transition it into manufacturing production, prototyping use by the department. Uh, I think if you're looking for private capital term exits, there's a lot of opportunity still. You can get some investment from private capital, you can get some S and T or SBIR dollars and you can exit by transitioning into a, uh, systems integrator. Um, I think, correct me if I'm wrong, we have yet to see a private capital backed company grow to the point to be a large systems integrator. But that might happen in the next decade.

Speaker B: Yeah, we're seeing a lot of growth among some of what they call the Neoprimes. So Android is a, is a classic example of what you'll, you'll see here. Uh, and uh, they say that the leadership of Anduril says explicitly they want to grow, to become a new prime. So uh, one exit path we will see is if that works out, we'll see new primes, we'll see very large businesses that have a lot of different diversified platforms that are publicly traded. That's, I think what they mean when they say they want to be a Prime. There may be other paths. Exit could mean selling to one of those primes. That's a classic path. Uh, exit could mean merging with another company. Uh, so I think all those things we're going to continue seeing, um, and I want to emphasize the point you just made about transition, which is that uh, all across the spectrum of different kinds of capital, different asset classes, the investment community is very focused on, on transition because that's how they get paid. So many venture capitals, if capitalists, uh, if you talk to them, they might be retired founders, they might be someone who, the reason they're, they have money to invest in you is because they've exited a bunch of other companies that they were able to coach and help them to grow and to transition in the commercial sector usually, but also in the defense sector. So when we think about why is this important and how does this play out when it's successful. One of the ways that private capital can be helpful is by having an investor involved in a company that is an expert in transition and is helpful in motivating them and providing capital for the company to figure out its exit plan. Um, and so I think that's a very healthy part of the capital markets too. It's not just the capital, it's the access to that talent and that expertise.

Speaker A: So you've done a huge amount of work in this space, um, from the reports to the articles to the short courses to the webinars. What do you got planned next and how can people work with you if they want to?

Speaker B: Well, we're part of a trade association so we want to continue to make sure that all of our members are benefiting uh, as there's more attention paid on private capital than defense industrial base. So we want to hear from our members, we want to continue monitoring what the trends are in the defense industrial base in terms of the access to financial services, uh, and the vibrancy of the investment environment. Uh, we are planning on doing educational opportunities. So as you mentioned, last year we had a short course that was offered here at NDIA focused on both government acquisition personnel and also defense, uh, contractors, helping them understand some of these things in a little bit more depth and navigate them. We're going to do that again in it looks like late September actually. Registration is open on our website. So we're going to have a two day course, uh, and we'd like to try and make that a recurring program uh, and really help, help uh, the community to uh, continue navigating this uh, and also continue routing interesting observations and recommendations to us. We don't think these will be our last publications on this topic. Uh, we hope to continue monitoring it and hopefully making useful recommendations um, to the defense industrial base.

Speaker A: Sam Moyer is a research fellow at NDIA's Emerging Technologies Institute. Thanks for joining us. Thanks Aeropolic and I want to thank everyone for joining us for another episode of Emerging Tech Horizons. If you enjoyed this podcast, please don't forget to like our episodes and subscribe to our channel to stay up to date with all of our latest content. This podcast is available on YouTube as well as anywhere you get your podcast. Please be on the lookout for information on the upcoming NDIA Emerging Technologies Conference which is going to be held September 8th through 10th in Washington, D.C. september 9th and 10th at the Washington D.C. convention Center. September 8th is a classified set of sessions at Potomac Yards Institute for Defense Analysis. This conference is now in its fourth year and this year we're going to have great keynote speakers from places like the Office of Secretary of War, potentially talking about Sam's Private Capital Initiatives, as well as eucom, africom, the Chief Digital and AI Officer, and the services. On top of those keynotes, we're going to have breakout panels and sessions being organized by NDIA's technical divisions. We'll have technical presentations and posters by subject matter experts. There'll be tech demos on the exhibit floor as well as our second annual Global Hackathon. For the first time this year, NDIA and the Society of Defense Financial Management is co sponsoring the Data analytics and Decision Support Conference which is going to be co located with the Emerging Technologies Conference. That conference is going to have discussions about how emerging technologies can support data analytics and decision support for the financial management contracting, audit community and the budget community as well. Registrations for the conference open up on June 17th. Please visit the website at ndia techexpo.org uh, special thank you to Melanie Yu for producing this podcast. Thanks so much for tuning into Emerging Tech Horizons. Sam.