Despite being one of the country’s havens for cybersecurity company development in the United States, D.C. is currently experiencing a dearth of VC funds catered specifically to raising them up for federal work. To learn more about one company that is taking charge, we spoke with Seth Spergel, vice president of emerging technology at Merlin International and team leader at Merlin Ventures.
ABERMAN: Well, tell our listeners: What is Merlin Ventures?
SPERGEL: Merlin is a company where we have partnerships with a lot of the leading cybersecurity companies, to help get them into the federal market. So, these are larger companies, some of which are public, some of which have been around for years. And what we saw was, there were a lot of earlier-stage companies that weren’t quite ready to work in federal, but potentially had really interesting technology that, when packaged with those larger companies, could really solve some interesting problems. So we set up a venture arm to find those companies, invest in them as a VC, pull them into our portfolio and be able to bring them to market together.
ABERMAN: How does a corporate venture investor look at things? Is it based on return, like a private fund, or are there different views?
SPERGEL: I think it depends on the firm, and also what it says on paper versus what they actually do. I think when you talk to a lot of corporate venture funds, in theory, they’re purely strategic. They’re looking for companies that have innovative technology that’s going to change the way they do business, companies they want to keep tabs on, companies they want a foot in the door with. When you actually sit down and talk to some of the people doing the investment for those companies, though, yes, that is their general charge, but they’re really trying to also find companies that are going to have outsize returns. And then, they back into how it fits within the company.
For us, it’s more of a balance. Obviously, we are doing this for financial reasons, but we’re really trying to find companies that match very well to our portfolio, because from our perspective, if we can’t sell the product, even if that company does very well with their exit, it’s something of a failed investment for us. We’re really looking to companies we can add a lot of value to on the sales side.
ABERMAN: From the standpoint of traditional VC models, it’s putting money to work with the expectation of making more, but arguably maybe you’re making better investments that are additive to the business strategy, because you have to ability to do due diligence within the industry, have domain expertise, and also have a ready selling channel.
SPERGEL: Right. From our perspective, we can put the thumb on the scale. We can find companies that we think will do well, but then, if we can execute on the sales side for a startup, if you can add a few million in revenue for them, that can be a significant return for that startup on the investment side when they eventually have an exit.
ABERMAN: You were at In-Q-Tel previously, and that’s their model as well. So, this is pretty familiar to you.
SPERGEL: Yes. That was why I liked this opportunity. It was a chance to do what I had done at In-Q-tel, which I really enjoyed, but put my own spin on it, make some changes and improvements. And so, that’s why I jumped at this.
ABERMAN: So, what kind of investments are you making through Merlin Ventures?
SPERGEL: Merlin as a company is really focused on the cybersecurity space. The furthest we get from that is identity and access management. So, we’re really looking for things that fall into that space and complement that. A lot of our investments, because of the markets we sell into, are driven by what the federal government is looking for, and so, the CDM program, which really defines a lot of the cybersecurity strategy for the federal and civilian market, drives a lot of those investments. So for instance, an upcoming phase of that is around data security, so those are the types of things we’re looking at right now. There’s obviously a lot of federal initiatives around secure developments, SecDev ops tools, and then of course the better mousetrap. What is the better way of securing networks? Those are always of interest to us.
ABERMAN: What’s your model? Are you investing in earlier-stage, on your own, 500,000 dollars with other people? What does investing from Merlin Ventures look like?
SPERGEL: We’re pretty flexible. Our real requirement is that it’s a product we feel we can actually bring to market. So, we typically look for series A or B companies, where they’re mature enough to have a product that’s ready to be used in enterprise, but not so mature that our investment is meaningless to them. Our investment sizes have ranged anywhere between one to ten million, it really depends on what makes the most sense with that company, and with us, and our relationship with them. But our structure is that we find those companies, we invest in them, and then we pull them into that sales portfolio and help take them to market.
ABERMAN: A lot of corporate VCs won’t lead a round, they’ll only invest alongside a private fund. Is that your approach as well?
SPERGEL: Typically, yes, although we have led a few. It really depends on what makes the most sense, and how strategic an investment it is for us. For ones where we really see it as an opportunity to build on top, and use our in-house integration capabilities to build something builder, those will go on a little larger. But others, we’ve absolutely followed them instead of leading.
ABERMAN: You’re like a scout team.
SPERGEL: Exactly. We’re trying to find where the market is going, and find the technologies we think will help push it there.
ABERMAN: Many of our listeners are entrepreneurs, I’m sure more than a few are starting cybersecurity businesses. Why, from their perspective, would they want to take your investments instead of a traditional private VC firm?
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SPERGEL: That was one of the things I thought was really interesting about this model. The challenge with being a VC right now, unless you’re a top-tier VC, is that it’s hard to get above the noise. There are just a lot popping up everywhere right now. The idea behind what we’re doing is, we’re not just giving you money and walking away, it’s more the sales channel that comes with it, and the exposure to these larger federal markets. And actually, for some of our earlier-stage startups, we even bring them into commercial markets as well. It really depends on how much presence they have and where they want us to invest. But it’s really that piece of it: that money is nice to have, in terms of helping you get to the next level on the engineering side, but it’s the sales acceleration that we see as the real value of our model.
ABERMAN: So, if done well, it’s the best of why I’d take money from a corporate venture if I was in business. It gets me into a pipeline, it gets me someone who’s interested in my success. It makes a lot of sense. I’d think you’re finding a lot of interesting businesses to invest in, but what is your view of the local cybersecurity startup market? How does it differ from New York, or Austin, or California?
SPERGEL: I think because of the government presence, things like the intelligence community, NSA folks leaving and starting their own companies. So you do have a really strong cybersecurity presence. I think if you look at the types of companies popping up in D.C. relative to other areas, cybersecurity really pops out. You also have companies that understand the government, and have really thought about that market as they design their product. We’d like to think we can take most companies into the federal government, but it’s a question of how heavy that lift is. With federal, I think you’ll find that just because entrepreneurs have experience with working in that market, they’ve thought about it ahead of time, and have designed their product in a way that that lift isn’t as heavy. So, it’s worked out well for us in that respect.
ABERMAN: During the Obama administration, there was a lot of focus on contract innovation, finding ways to get garage inventors into the government. From my perspective, a lot of that has dissipated. What’s your perspective? Is this administration as interested in working with startups and new technologies?
SPERGEL: I don’t know how specific it is administration to administration, but I think actually, if you look right now, there is still a lot of activity popping up from the federal government. It seems like there’s a pretty healthy ecosystem of federal support for startups getting access to government.
ABERMAN: Where are you on what I’d call edge technologies? Quantum computing, AI, things that are clearly where cybersecurity is going? Are you investing ahead of the curve, or does it have to be something that’s more quickly sell-able to the government?
SPERGEL: We’re talking to those companies, we’re tracking them, but from our perspective, it’s a little bit early. When I was at In-Q-Tel, we’d look at those types of things, and even there, they tended to be early for us. Here, we’re very focused on what we can sell today. So, quantum cryptography isn’t really there yet. So we’re not going in heavy on that, but we’re keeping tabs on where the industry is heading.
ABERMAN: As you talk with entrepreneurs that are doing interesting things here in town that could be part of the pipeline five years from now, what do you tell them to do, from the standpoint of starting a business, if they’re not able to raise venture funds?
SPERGEL: You do have a lot of the accelerators, or incubators, that have started up to help companies do that exact sort of thing. We do a lot of work with Mach 37, which is one base in Virginia. They’re looking for these very early-stage companies that are more of a technology and an idea than a full-fledged business, to help build that out. So, that’s one option. The tried and true way of doing it in D.C. is to start a consulting company and build something out, and eventually turn that into a product. That’s another. It really depends on the resources the entrepreneur has, and how dedicated they are to this opportunity, and what type of opportunity it is.
ABERMAN: I think you’re right. Consulting then converting to product is the way to go. I think that federal R&D and small business innovation grants are good ways to go. Even looking at things like Siri, that came directly out of DARPA grants.
SPERGEL: Right. So much of the technology we use has come out that way.