The Small Business Administration and the Defense Department recently launched an effort to boost private capital investment in critical technologies. The program will provide federal guarantees to investment in companies the Defense Department considers critical. To discuss, Federal Drive Host Tom Temin talked with the SBA’s Associate Administrator for the Office of Investment and Innovation, Bailey DeVries.
Tom Temin And for clarity, this is not one of the efforts that I know SBA is involved with and DoD’s involved with to get commercial products over the so-called Valley of Death or to get new products into commercialization. This sounds like it’s more aimed at getting the products developed in the first place. Tell us what’s going on.
Bailey DeVries Yes. So we’ll cover the spectrum of early stage through growth and scale. The way I would think about this is that building on the long standing and successful relationship that the Department of Defense and SBA have had through the Small Business Innovation research and tech transfer programs, which do address the federal support of those earliest of ideas for research and development and prototyping and support for commercialization. This is a broader effort to connect capital in the U.S. to those that are developing technologies that seem to be and are known to be critical to our broader U.S. national security. So those could be technologies that are purchased by the Department of Defense, but they might be other technologies that are not going to be procured by the Department of Defense, but we see as vital to our long term economic stability, growth and national security. So I hope that that paints the picture of how this is broader. There will be some investors that may invest in that critical stage of commercialization, but there are different needs and gaps in the market today when it comes to critical technology areas.
Tom Temin And one of the documents states that this program it’s called [Small Business Investment Company Critical Technologies (SBICCT)], will get whatever it is later. It says will support licensing that is additive and complementary to free market activity, avoiding existing areas of efficient and effective market activity. So if something does have commercial appeal or it might be something defense would want. Why would capital have not found it in the first place?
Bailey DeVries It’s an excellent question. So the way to think about this, right, is that there’s always the consideration of relative value where investors would place dollars based on considerations such as perceived or actual risk, the duration of those investments. There are many factors that are considered. And so by the federal government through the Small Business Investment Company program, the SBIC program, which is a 65 year old longstanding program that was developed during the Eisenhower administration, so that way the federal government could provide additional financial support for funds that are investing in small businesses and startups. Through that program, we are able to shift the risk return of these funds. So I can give you a great example. So of the critical technology areas, there are 14 in total, by the way. Some of those areas would require very long duration investment or very capital intensive investment. So if you think about such technology areas as quantum computing or space technology or different facets of the renewable energy market or hypersonics, the duration of these investments and often the capital intensive nature when compared to investment, say in SaaS, software as a service type of investments, does not necessarily appeal to returns seeking investors as they have a fiduciary responsibility. However, if through the use of a government guaranteed loan, we can shift the overall risk return of those pooled investment vehicles, then such investments could be more attractive financially to private market investors. Add to it through the SBIC Critical Technologies Initiative, the Department of Defense providing programmatic resources and support to further de-risk those investments. And we have conviction that this proven model through the SBIC program will be capable of helping to increase the supply of capital flowing to these technology areas that we have strong belief need greater investment.
Tom Temin We’re speaking with Bailey DeVries. She’s associate administrator for the Office of Investment and Innovation at the SBA. So you’ve got kind of an oversight two layer challenge, I think, because, one, you want to understand that the investors that you are backing don’t have backing elsewhere. And the risk is sufficient that the government guarantee should be there. And second, that the companies that they’re investing in that are in these critical technologies have some kind of realistic base that they’re operating from and are actually viable outfits and not just people. There’s a loan guarantee. Let’s get some capital.
Bailey DeVries That also is the elegance of the approach of the Small Business Investment Company program, the SBIC program, where the federal government doesn’t work, point to point with individual small businesses and startups. But we work with partners with deep expertise in performing due diligence on companies in a particular segment of the market, at a particular stage, in particular industries, and then they invest in a basket of companies. So typically somewhere between 15 to 30 companies would be within a fund structure, And therefore, the risk is pooled and there’s an intermediary in the middle that has deep relationships within that part of the market and can allocate capital and allocate risk across that basket to seek to provide a financial return and also advance innovation within their area of focus. So different from other loan guarantee programs that you see in the federal government, where the federal government would be providing direct support to an individual company. The SBIC program solves for that idiosyncratic single company risk and instead supports the growth and development and financing of broader baskets, which enables us to advance innovation within different segments of the economy and also work collaboratively with the private sector to advance those technologies and fund the future of innovation.
Tom Temin So you and DoD then are not on the hunt for these companies. They are known to risk investors that can pool and roll them up for you for that guarantee.
Bailey DeVries Exactly.
Tom Temin And you’re threading, I guess, a pathway among the SBIC program that you mentioned, among the idea of simply research and development grants such as [Defense Advanced Research Projects Agency (DARPA)] might award. And then the whole idea of challenge competitions, which are low dollar types of things intended to kind of float up people that might have great ideas. It’s somewhere among all of that.
Bailey DeVries Yeah. So what I would say is different types of financing play a role at different points in the evolution of a company, and they’re not all separate and distinct. You have to think about the types of capital you need when and how you might layer them on at various points in time to keep the cost of capital for a growing business as low as possible. So that way they’re not servicing debt or decreasing equity to a level where they don’t have enough equity available for financial incentives for other employees or investors. So these are all different considerations that I would say that personally have a high degree of conviction, that the more we can do to not have gaps and to enable venture equity investment in early stage companies that are also pursuing federal grants or contracts simultaneously, the more likely we will be to nurture these companies and support them on their growth journey, particularly these companies that are frontier technologies that are going to be very capital intensive in nature and often very long duration. And so it’s not just going to be a grant that is going to enable the success and sustainability of that company. It is going to be in a range of different types of financing options. Additionally, the opportunity to create stronger networks of subject matter experts and support around a growing company is critically important. It helps with customer relationships, it helps with future financing, it helps with good governance of these businesses. So strengthening the networks around these companies is critically important.
Tom Temin And you mentioned there are 14 technology areas. What tops the list here?
Bailey DeVries Yes, I’ll give you the list. And this is the Department of Defense. So research and engineering, R&E, they publish the 14 critical technology areas. They are biotechnology, quantum science, future generation, wireless technology, Advanced Materials, Trusted AI, integrated Network System of systems, microelectronics, space technology, renewable energy, advanced computing and software, human machine interfaces directed energy, hypersonics and integrated sensing and cyber.
Tom Temin Well, that just about covers the waterfront.
Bailey DeVries It’s an extensive list.
Tom Temin And is there money out already under this program? The agreement between DoD and SBA was signed just in late September.
Bailey DeVries So we signed our memorandum of agreement to partner back in March, which is really exciting over at South by Southwest. And then in September we published our investment policy statement for the program following changes in regulations to the SBIC program. And since then, we have received a number of applications from funds that are interested in applying for an SBIC license under the Critical Technologies Initiative. So we are in the process of performing due diligence on those funds through our licensing process and excited about the pipeline of investors that are interested in the program and look forward to sharing more in the weeks and months ahead.