E415: Why Every VC Is Suddenly Investing in Defense

For years, defense investing was considered off limits for most venture capital firms. Today, billions of dollars are flowing into defense startups as AI, drones, autonomy, advanced manufacturing, and national security become some of the biggest investment themes of the decade. David sits down with Jake Chapman, Managing Director at Marque Ventures, to discuss why defense became mainstream, how government procurement is changing, why Anduril and SpaceX transformed venture investing, where the biggest opportunities still exist, and why the next generation of iconic venture-backed companies may be built around national security rather than consumer software.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Speaker 00

  Why is everyone in Silicon Valley suddenly investing into defense tech? If you zoom out, venture is a trend-driven business. Before defense tech, it was maybe crypto and before crypto, it was creator economy. And before that, it was solomo or something, right? So defense just happens to be the trend today. But I think the meat of your question is, why is defense the thing of the day?

• 0:26Speaker 00

  And I think there's a lot of reasons for it. One is just the people can look at the world today and just see there's conflicts sort of everywhere brewing. You've got this big macro competition between the US and China. You've got the war in Ukraine. Northern Africa is sort of a mess. Obviously, we're fighting over the Strait of Hormuz with Iran. And so there's big macro trends driving interest in defense. And then I think you also saw in the last few years, just a change in the attitude around whether or not defense could be a successful investment sector, largely driven by three companies. I think Palantir, SpaceX and Anduril really proved that there was some meat on that bone. And that brought a lot of interest to the space.

• 1:09Speaker 00

  When I think about this, I think about it as self-reinforcing. A lot of these spaces, they become hot because there's one or two, or in this case, three winners. And now capital gets returned. Now founders pursue that space. And now suddenly there's a market. How much of that is what's driving defense? There's definitely a pheromone of that. So you have a lot of companies being founded today in aerospace and defense with former SpaceX engineers. Certainly former Palantir engineers are out there now as a mafia developing.

• 1:44Speaker 00

  And I think you'll start seeing former Anduril engineers doing the same thing as they're hitting the scale they're hitting now. There's definitely some truth to that. The ecosystem has a flywheel effect that's taking place. There's also a Department of War angle to this, too. Their policy have changed. Tell me about that. Lot of changes happening in the Trump administration. So Department of Defense, Department of War, depending on who you ask, has been a really challenging customer to work with for decades. For a hundred different reasons, which we can dive into. In the last administration, the first Trump administration, a little bit in Biden and certainly now in Trump, too. A lot of effort has been made to make them a better customer.

• 2:28Speaker 00

  And so that's things like aligning the R and D funding with future acquisitions. So companies don't get lost between the two sides of the house. The department is broadly split between research and development and then acquisitions on one side or on another side. It's getting rid of sort of regulations and red tape that make it very expensive or challenging for companies to work with the department. Just yesterday, actually, the government suspended or eliminated something called CMMC, which was a cybersecurity requirement that imposed hundreds of thousands of dollars in costs on startups. And it was driven by a real desire to solve some cybersecurity challenges in the defense industrial base.

• 3:11Speaker 00

  But it made it almost impossible for young companies to do business with the government. And that requirement is now gone. So some pluses and minuses there, but I think generally a net positive for the ecosystem. So it's a lot of things like that are happening. Everybody realizes defense investing is hot right now. How has that evolved over the last couple of years? I'll talk a little bit about the size of the market and then we can talk about the investment dollars going into it. So the Department of Defense's budget is, when I started investing in defense back in like 2019, 2020, was around 800 billion, maybe a little shy of that, maybe a little over. Last year, it was over 900 billion.

• 3:55Speaker 00

  This year, they're talking about a $1.5 trillion budget. I don't think they'll quite get there, but quite large. Put that in perspective, the global SaaS industry is something like 250 billion a year. You can add on to the US's defense budget, the allied and partner defense budgets. And that's probably another trillion-ish dollars, maybe a little shy. Depends on whether or not Europe meets its NATO commitments. And then you can layer on the domestic law enforcement budgets, federal. So you think like the homeland security budgets, you layer on the intelligence community budgets, you layer on black budgets and you end up with the defense ecosystem being probably fairly well over a $2 trillion a year market. Not a lot of markets of that size. So pretty impressive.

• 4:39Speaker 00

  If you go back to 2019, 2020, I would say there were single-digit billions in venture or private equity, early-stage growth dollars going into defense. And now it's well over 100 billion a year.

• 4:54Speaker 00

  Remains to be seen if that investment is met with actual acquisitions from the government. But certainly it's starting to ramp up. How much of this is driven by a new type of warfare? Whether it's drones, what some call asymmetric warfare, where you have these very expensive equipment being attacked by these very cheap drones? Certainly, a lot of the new investment, a lot of the venture investment is going into that side of the equation. Ultimately, a lot of the budget still goes to large legacy programs and what are called exquisite systems. So sort of the other end of the spectrum. So your F-35s and aircraft carriers. That's starting to change and more of the budget is moving towards the asymmetric side of the equation.

• 5:38Speaker 00

  Small drones, cyber, electronic warfare systems, things like that. And a lot of that is being driven by what we've seen in Ukraine. So what's been effective there? I think something like 70% of the casualties in Ukraine, maybe higher, maybe more like 80%, are caused by FPV drones. So not artillery, not guns, but drones. 80%, probably a decade ago, zero. There were drones in Iraq and Afghanistan, dropping a stray grenade here or there. ISIS or the Taliban piloting those, but we're talking like onesies, twosies. Nothing like what's happening in Ukraine today. Is defense also going through this evolution where it seemed like

• 6:21Speaker 00

  five years ago, everybody was going for these relatively low capital intensive challenges like drones? And today you have companies like Castilian going for hypersonic missiles and much more capital intensive projects. Even several years ago, there were lots of companies trying to build the capital intensive things. I think that there were fewer investors willing to take risks on those companies.

• 6:45Speaker 00

  And so what those companies were doing in like sort of the traditional processes, they were receiving a lot of government R and D dollars, grants to help build those technologies. And were basically locked out of the capital markets because most venture investors were not willing to put $10 million into a company trying to build hypersonic missiles. Because that company would probably need to raise, let's say, $200 million or $300 million over 10 years to get to a program of record and start actually selling to the government.

• 7:15Speaker 00

  And that's a hard bet to make, especially when you could make good money on a SaaS investment. AI is driving a lot of people out of sectors that they perceive as pretty vulnerable to AI and towards sectors that they see as a little bit safer or harder for AI to marginalize. And deep tech is certainly one of those places. I got into investing in defense, partially for like family history reasons and personal passion, but also because I was doing a lot of deep tech investing and realized all of the companies I was investing in had national security applications, but none of them were thinking about selling to the government. They had no idea that that was really a viable market for them.

• 7:55Speaker 00

  And so I started like digging into that market and how I could help them bridge that gap. And that's really what got me into the space.

• 8:02Speaker 00

  Jeremy Giffen has this pretty hot take on why there's more capital going after these capital intensive startups. And essentially, as venture capital firms get bigger, now you have these large mega funds raising billions of dollars, sometimes over $10 billion per vintage. Only 15 years ago, the largest venture fund in the world, NEA, was $3 billion. But now you have entire vintages being over $10 billion. And the second order effect of that is you now have to go after capital intensive. You have to justify, why am I raising $10 billion? It can't be to invest into SaaS startups or mobile applications. You have to go after hard problems and capital intensive problems.

• 8:43Speaker 00

  So it's in some ways, the capital that's driving the capital intensive projects, not the other way around. A hundred percent. And I think that's, in defense, it's also why you see some companies have the valuations they have. Anduril is a great company. One of the reasons I think their valuation is what it is, is because if you are T. Rowe Price and you have interest, your investors want you to be investing in sort of the new style of defense. You don't have a lot of options at that scale where you have to write $100 million or $250 million check. That makes sense. And so you have a lot of demand and not a ton of companies yet that are scaled to absorb that demand. And so valuations shoot up. So yeah, I think you're right.

• 9:27Speaker 00

  Same dynamic is playing out where you've got an Andreessen that has 50 billion under management. And how do you put that money to work? You need to find some capital intensive projects. Taking back to 2019, you had left your previous firm and you launched MARQ. First of all, tell me about the name. Why choose that name? It's MARQ, M-A-R-Q-U-E. And so we violated the first rule of marketing, which is you should never have to spell your name for anybody. And I always have to spell it.

• 9:59Speaker 00

  So we named the firm after a letter of marque and reprisal, which appears in the US Constitution in Article 1, Section 8, Clause 11, which grants Congress the right to issue these letters. So a letter of marque is the document that Congress can give you, the president signs it, that allows you or turns a ship captain traditionally into a privateer. So you are allowed to go fight your ship basically on behalf of the US government or at the time, the colonies during the Revolutionary War. And then anything you captured, you could take back to a prize court. And it was ruled legal capture. So you're not a pirate. You were in fact, a privateer. You'd sell it and you'd keep some of the proceeds and you'd pay taxes on that.

• 10:40Speaker 00

  And so this was one of the first historical uses of private capital, both literally money being invested in the ships and the crews, but the crews and the ships themselves are also capital for national security. And so we sort of adopted that as our name, private capital for national security.

• 10:56David Weisburd?

  And these are outside investors that were backing these privateers?

• 11:00Speaker 00

  Yes, so sometimes it was the ship captains would own the ships and have a letter and go out. But often it was private investors would get the letter, find a crew, find the ship, hire everybody and send them out. And so in a lot of ways, this is like also early stage American venture capital, because you've got the financiers taking a very high risk bet. But then you also have the crew and the captain who are out there fighting their ships, much like founders taking very high risk bets, but for a lot of payoff. If you landed a fat merchantman and brought it back and sold it at the prize court, you might be set for life or at least for several years. So similar dynamics to venture today.

• 11:41David Weisburd?

  There was power law outcomes.

• 11:42Speaker 00

  Power law out there as well. Yeah, you certainly could have ended up in an English jail or at the bottom of the sea.

• 11:47David Weisburd?

  There's about the upside and downside. It reminds me of the Dutch traders and the origins of carry and private equity funds. A lot of people don't realize private equity funds and venture capital. Actually, the concept of carry goes back to the Dutch traders in the 11th century. They would come and take different goods and they would carry them back. And they also had private investors and they would get 20%, literally 20% of the goods that they brought back would be given to the GPs and 80% would be given to effectively their LPs.

• 12:18Speaker 00

  Yeah, interesting. I mean, the whaling industry had similar dynamics too. So it's like venture really came out of a maritime tradition. Yeah, total tangent, but I think just as an interesting side note related to privateers. So the pirates of the Caribbean were real. And the reason the pirates of the Caribbean existed as a force was the Europeans were funding privateers. So same thing we did with letters of marque and reprisal in the New World, basically to hunt treasure ships of the other European powers. And at some point, they all got together and they decided that they were going to stop fighting each other in the New Worlds. And so they outlawed privateering.

• 13:00Speaker 00

  So what happened is you had all of these privateers in the Caribbean with warships, a bunch of young men, and they all get a letter from their respective kings saying, no more privateering. But what do you expect these guys to do? Now they're out of a job, but they have a bunch of guns and warships. They have a certain skillset.

• 13:18David Weisburd?

  Going back to defense and the space, what inning are we in when it comes to defense?

• 13:25Speaker 00

  I'm supposed to say early innings because that's what's good for my business. But I think it's true. And I don't want to be an ambulance chaser here, but the world is changing dramatically, the world order, right? So we had the post-World War II world order where America was really, first we had a bipolar world between the US and the Soviets. And then we had sort of a unipolar world where the US had complete hegemony. That's changing. We don't know exactly what it's going to look like. And I think it's probably a 20 or 30 year process to play out. And we are in very early innings of that process. And I think if you look at the conflicts that are going on in the world today, you can look at them all as discrete conflicts, but they're not. They're much more like proxy wars between US and China and that competition.

• 14:10Speaker 00

  That's just getting started. So I think we have 20 or 30 years before we see what emerges on the other side. And I'm hoping that when we emerge, it looks a lot like the mid 90s. But we'll see.

• 14:22David Weisburd?

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• 15:06David Weisburd?

  and expert transcripts to filings and earning calls. And they own the retrieval layer on top of it. So every answer links back to an exact verifiable source because the answer is only as good as what's underneath it. And with AlphaSense, you know exactly what that is. The edge goes to whoever could trust their information and prove it. See it for yourself. Start your free trial at alpha-sense.com/HowIInvest. That's alpha-sense.com/HowIInvest. You mentioned earlier that it was very difficult to deal with the government in terms of as procurement. Why was it difficult and what's changing today?

• 15:47Speaker 00

  Hundreds of challenges in selling to the government. I think if you zoom way out, one of the major challenges is it's rife with principal agent issues. So what do I mean by that? The end user, we'll call them the warfighter, but it could just be someone sitting at a desk who needs a new piece of software to make their job a little bit easier. The warfighter almost never has budget or purchasing authority, right? So you need them to be on board, like they need to like the product you built and give you feedback and want to buy it and advocate for you. That's not nearly enough in defense. So once you've got the warfighter on board, then you need to find a requirement that you fit with.

• 16:28Speaker 00

  So requirement is a bureaucratic process that the government runs where they basically determine whether or not a problem they have requires them to pay for a solution. So first, what they want is they say, okay, so we've got this problem. You've surfaced to us. Can we solve this by doing business slightly differently? So it's a new concept of operation, a new con op. If not, then can we solve it with something we already buy? Okay, if not, then maybe we'll buy something. Now that we know that we need to buy something, we're going to define exactly what it is that we need to buy. And that gets packaged into a series of documents. And once you have a requirement, now you need to get it funded. And so that means going to Congress, right? There's four committees in Congress that matter for defense.

• 17:11Speaker 00

  There's two in the Senate, two in the House. Two of those committees set policy. Those are the House Armed Services and the Senate Armed Services Committees. And then two of those committees actually set the budget. The defense budget, like I said, is a massive budget, but it's the most constrained of all federal agencies in terms of how they spend their money. So there's thousands of line items in that budget and accounts and subaccounts, very specific. And it's basically the only place in the budget where earmarks still exist. So the budget won't say, here's $100 million to Raytheon, but it'll say, here's $100 million to buy SM6 missiles. Well, there's one company that makes them, guess who it is, right? And so it's like, you have to understand now the sort of the congressional budgeting

• 17:53Speaker 00

  and their interests, which means like district and constituent interests factor into this. And then after all of that process gets run, you still have to find the right buyer in the DOD. So the person with contract authority, the office who's supposed to be serving that requirement. All of these players are required to be aligned to have a procurement go through successfully. So it's far from straightforward. And at each stage, there's a lot of red tape and some traps that you have to run, right? And so like, none of that, I think, makes sense to an investor who is not really focused on defense, because you just look and you say, this is the best technology solving this problem. Of course, they'll find a customer, right? It's a great team. But that's not how the government works, is this process.

• 18:38David Weisburd?

  This is the main reason there's been an oligopoly with these large defense primes? Or is there something else underlying that?

• 18:45Speaker 00

  There's a chicken and an egg issue here. I think that certainly the primes would argue, and I think they've got a fair argument to make, that the oligopoly exists because the systems were set up, not that the oligopoly set up the systems. So Congress basically shaped the incentives and then the primes built their businesses around those incentive structures and we ended up with what we have now. When you create a lot of bureaucratic hurdles and red tape and you require people to build things that are capital intensive and you make budgeting processes, take multi-year efforts, you end up with companies that look like the primes,

• 19:24Speaker 00

  because you have to build a company that can survive that, where you have a small subset of engineers and relatively small internal R and D funding, but giant teams of lobbyists and lawyers and, you know, capture specialists to go after contract vehicles and they become financial firms, basically.

• 19:41David Weisburd?

  And then it encourages these economies of scale and then they figure out they're in a market where they could now keep new entrants from coming in. They hire the lobbyists and regardless how it started, it always ends up in this recursive thing where the oligopolic nature of it is driven by the government and the defense contractors are furthering it.

• 20:02Speaker 00

  That's right. Tell me about the Last Supper. Last Supper, this is not the biblical Last Supper, but this is the apocryphal, although it's not really apocryphal. This is the story of how the defense industrial base consolidated. So post-World War II, there are tens of thousands of companies working for the Department of Defense as private contractors, building things, right? And so some of them are mom and pop, most of them are mom and pop shops, building bolts and widgets that then get put into other aircraft. And some consolidation and verticalization starts to happen post-World War II, but not a lot. And so you still have like dozens of large firms, hundreds of medium-sized firms, and then tens of thousands of small mom and pop shops. Fast forward to the 90s.

• 20:48Speaker 00

  We win the Cold War and there is a great deal of pressure on Congress to reduce defense budgets. So we don't have any more enemies. It turns out that that was not true. That was the thinking. We had sort of won the future. And there should be a peace dividend. So instead of spending 5% of GDP or 7% of GDP on defense, we want to bring that way down.

• 21:11Speaker 00

  We decided to bring that down, I guess, to about 3% or 2.5% of GDP. And what the department realized was if we're going to slash defense budgets, a lot of these companies are going to go out of business. Makes sense. We are their only customer. But we can't afford to not have any American companies that make fighter jets or aircraft carriers. So what do we do? And what they decided was that they were going to summon all of the CEOs to the Pentagon for a dinner. And over the course of that dinner, they explained to them what was going to happen and basically said, look to your left, look to your right.

• 21:49Speaker 00

  One of you is going to be out of business at least, and so we highly encourage you to consolidate. And the result of that was exactly what they had requested was major consolidation. I had a chance to chat with the CEO of Lockheed, that he was the CEO of Lockheed at the time, Norm Augustine, absolutely brilliant human being who was in that dinner and he was telling us, before he went to the dinner, all the CEOs were like calling each other because they had never been summoned to the Pentagon for a dinner before. And so they had no idea what was coming. But he took that talk to heart and he went and at the time, I think he was the CEO of Martin. And then they acquired Marietta and then Lockheed. And so now it's Lockheed Martin was Lockheed Martin Marietta. They all started to consolidate. And so now we have

• 22:35Speaker 00

  a half dozen major defense primes and then a couple dozen sort of medium-sized primes. But these are your Lockheed's, Raytheon's, Northrop Brumman's, General Dynamics. This is the result of the Last Supper.

• 22:50David Weisburd?

  And then today you have the Neo primes, Andrell, Sironic, I mentioned Castilian, trying to enter the space. How are they able to enter a market where there seems to be such barriers to entry?

• 23:02Speaker 00

  The barriers are starting to come down is part of the answer. I'll take from Andrell's perspective. So Andrell, like one of their major business insights was instead of relying on government funding for research and development or product development, we are going to fund our own product development. And then we are going to go try and just like compete in the market. So this is like following somewhat on the SpaceX and Palantir model. And to do that requires a lot of capital. So they assembled a team, sort of like a super band, Palmer Lucky and Trey Stevens and all the folks they brought in, raised a lot of capital at a hefty valuation, even relatively early on, to survive how long it would take to win the government over as a customer.

• 23:48Speaker 00

  Started internal development, built great products and went from there. That's not a model that the average founder could have done five years ago or even two or three years ago. It is becoming a model that is slightly more viable as the barriers get knocked down and as more capital has rushed into the space.

• 24:07David Weisburd?

  I'm always fascinated by these category makers like SpaceX. There was no real space tech before they started SpaceX. Andrell, there was no real Neo primes. How were they able to go from zero to one? Double click on the founding story.

• 24:23Speaker 00

  I think extremely challenging. So always a little bit of luck involved. They found, I think, a market that not a lot of people were competing in, where they could

• 24:35Speaker 00

  sort of get a foot in the door. They began, I was not a founding investor in Andrell, so this is maybe an apocryphal story, but I think they started with the Sentry Tower product.

• 24:47Speaker 00

  They started working with the Department of Homeland Security, putting Sentry Towers sort of on the border to monitor crossings. And that was an area where they didn't have a ton of competition at the time. And then they've horizontalized from there and expanded into new markets.

• 25:01David Weisburd?

  They found a beachhead and they executed really well, which gave them the right to go after other products. How would you go about mapping the defense technology market today? What are the different categories that are most compelling, both for entrepreneurs as well as investors?

• 25:17Speaker 00

  So there's definitely categories that I think are over invested in. The quintessential one there being small drones. There's a thousand small drone companies. We probably need four of the, you know, group one drone companies. And there's a couple of really good ones out there already. Neos announced, I think, yesterday, I saw a $500 million contract to make small FPV-style drones. But there's a million companies out there building those.

• 25:46Speaker 00

  I think areas that are under invested in right now, manufacturing, a lot of money going into advanced manufacturing, but it will be a 20-year effort to onshore or fringe shore. A lot of what's left over the last 30 or 40 years, it'll require trillions of dollars. People think of advanced manufacturing as one category, but there are so many different things that go into it. Tooling and die, forging, foundry work. There's a lot of space in manufacturing still to go and that's really critical to American national security. Most founders and investors are investing in tactical technologies, right? Small drones, battlefield tech, something that a soldier might use.

• 26:27Speaker 00

  Almost nobody is investing in strategic technologies, the quintessential strategic technology being a nuclear weapon or weapons of mass destruction. But there are other ways of thinking about strategic weapons or technologies. Those are the things that like are almost political in their use. They really reshape the battlefield. And I think lend themselves to venture, since in venture you really are looking for kind of home run technologies, home run wins. Not a lot of companies working in that space.

• 26:53Speaker 00

  EW, so electronic warfare, very interesting space. Cyber. And we'll see how all these things get impacted by AI. Cyber for sure, being heavily impacted right now.

• 27:06David Weisburd?

  The intersection of cybersecurity and defense.

• 27:09Speaker 00

  That's right. Yeah. The Mythos release where they sort of pumped the brakes because it was discovering a bunch of zero days. So what does that mean for the traditional cyber defense firms? What does that mean for cyber offense? Can you build a sustainable business if the frontier models are able to sort of fairly easily

• 27:28Speaker 00

  work in the cyber domain in ways that humans really can't? So you have like the, if you're going to segment defense, you have like those areas. So you've got tactical technologies. You have strategic technologies. You have sort of your software, your hardware. And then you have companies that are building sort of in a specific vertical. And then you have companies that are building platform plays, right? So Andrell being the largest of the platform plays today, I think Mock Industries being another one, trying to, to build sort of a very horizontally integrated defense prime contractor, someone who can compete with a Lockheed or a Raytheon. Not a lot of companies building that today. Almost always when we're chatting with LPs, they'll ask like, how do you find the next Andrell?

• 28:12Speaker 00

  And my answer is usually you don't, like you look for a company that's building a great product that has a wedge. And you just hope that the team is smart enough and sharp enough to eventually build up a platform company, but very hard to. Start out on day one with the intent of building a platform company.

• 28:32David Weisburd?

  Side of technology and the quality of the product. What are the other characteristics of things that make the best new defense technology companies?

• 28:43Speaker 00

  Obviously, technology market for it, like demand, future demand. Use the Wayne Gretzky quote, you gotta skate to where the puck is going, not to where it is today. Founding teams, like all the things you look for normally when you're doing venture investments. But I would say for us, like, it really goes back to what I talked about earlier. The way government acquisitions work. We look to see, we talk to the warfighters, right? Who are the end users that are using your product? Which means that we don't normally do pre-seed, right? Like, we're looking for companies that have a product, maybe not in the market, but prototype they put in a customer's hands, usually.

• 29:21Speaker 00

  So we talk to those folks. We go to exercises here in the States and then abroad. See how the products are actually getting used and how they work. We talk to the requirements writers. A lot of that is classified. We all hold clearances at the firm. It's crazy to be investing in this space. Maybe not at pre-seed, but almost anywhere else if you don't have anyone with clearances at your firm. There's actual information asymmetry in defense and it's institutionalized through the security clearance process. Requirements are often classified. Some exercises are classified, where the technology is getting used. The results of exercises can be classified. Just because you have clearances doesn't mean you get access to that information. But if you don't have clearances, you're definitely not getting access to that information.

• 30:03Speaker 00

  The budgets are classified, other than like this year's budget. It's a very like odd space to be investing in.

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• 32:20David Weisburd?

  Maybe you're buying a home, starting a family, planning for college, or simply thinking more intentionally about your financial future. As those responsibilities grow, it's worth making sure you protect those you love. Not sure what kind of life insurance you may need? Concerned about how much it may cost? Think life insurance is too complicated? Your local State Farm agent can help answer those questions. They can help you explore your options for life insurance and choose coverage that you can adjust as your family's needs change over time. Financial protection for your loved ones when it matters most. Learn more about life insurance at statefarm.com. Like a good neighbor, State Farm is there. That a venture capitalist would have access to this information?

• 32:56Speaker 00

  The old trope that like you don't have a need to know is true in the clearance world. Like, you could have a clearance, it could be top secret clearance with sort of the special tickets attached to it. That doesn't mean that you get access to information unless you have a need to know that information. So I'll start out by saying that. So just because you have clearances doesn't mean you get to know where the bodies are buried or the aliens are being hidden. But the government overclassifies things.

• 33:22Speaker 00

  Some of the things they classify routinely as policy are the requirements. So I guess they run that process. So the actual requirements are often classified. Now, they might come out publicly and say, we need to buy something that does X and Y. Really what they're looking for is something that does Z and like they're analogizing Z to X and Y. So they don't have to tell you what the classified requirement is. But if you want to know what they're actually trying to do, that might be classified. The Department of Defense is actually quite communist in how they set their budgets. They do like five-year plans. The extended spends are classified. So you can see what this year's budget is because Congress is passing it. Other than sort of like the black budgets, but like where the money's going to go long-term?

• 34:06Speaker 00

  They have a plan and not everybody gets to see that plan. So being able to have a frank conversation with the government customer, whether it's about how a company performed at an exercise, what it is they need to buy, or how much money's going to go to it, might require you to have access to that information that is not available to the general public. There's like probably a dozen firms that have clearances, but not very many.

• 34:33David Weisburd?

  How do the founders that you look for in defense tech differ from world-class, non-defense founders?

• 34:40Speaker 00

  The trope of like the 20-something Stanford GSB grad. Certainly, that founder archetype can be successful in defense. But I think defense has a lot of characteristics, kind of like pharma, where it pays to have some folks with gray hair on your team that have been in the industry for a long time, have really good industry contacts. And that is both contacts within the government and with the prime contractors. Early on, for a new defense company, if you're cautious and you protect your IP and you sort of know what you're getting into, it's great to work with the primes. The primes have done the hard work of landing large, multi-billion dollar contract vehicles to produce a product.

• 35:22Speaker 00

  And their job as a prime contractor is to go hire subcontractors to perform a lot of the work on that contract.

• 35:30Speaker 00

  So having relationships with the primes, knowing how they do business, having relationships inside the government, knowing how they do business, very important. That usually means a slightly older founder who's coming from the sector. I think it's a very hard space to just have a bright idea and a cool tech and build it and break in.

• 35:48David Weisburd?

  And part of that is the R and D part of the government and acquisitions. They don't really talk to each other. They don't collaborate as closely.

• 35:57Speaker 00

  It used to be one organization and then it was split between research and development, RDT and E. So research, development, testing, and evaluation. So all of the work that goes into early-stage prototyping. And then the organization that is designed to acquire stuff at scale. So it used to be one organization, now it's two. Five years ago, the research and development organizations often did not talk to the acquisitions organizations and vice versa. And so you might have a lab, we'll say a lab that's working on alt-PNT, which is positioning, navigation, and timing. So think GPS. What do you do when GPS is being jammed or denied? You need a new technology that like helps you figure out where you are and what time it is. So there might be a government lab working on that that is funding 10 companies.

• 36:42Speaker 00

  R and D for 10 companies, working in different modalities. And then you've got one program office on the acquisition side for the Air Force, who is supposed to be acquiring new alt-PNT technologies. That acquisition arm might not have been talking to the lab. And so you might have companies that for five years are working with the lab and taking government money, perfecting a product. And then they go to the acquisition side and they say, hey, we're ready for you to acquire us. I'm at scale and the acquisition side says, I don't have any idea who you are. I'm going to go buy this other product from Lockheed, who wasn't doing any work with the R and D side of the house. And that leaves a bad taste in everybody's mouth. It's wasted money. It makes the founders of those businesses feel like the government doesn't care. There's a lot of dysfunction.

• 37:27Speaker 00

  That is starting to break down. So there's still two different organizations. But like the Army, for instance, created this program called Fuse this year, which takes a lot of older, sort of disparate Army programs. And rather than having them run independently, has sort of like stacked them in serial. And so companies can enter at gate one. There's one team that's then managing them from gate one to gate two to gate three. And so you're not having that sort of disorganization happen in the Army in quite the same way as it used to. And I think we're starting to see that across the other services. So I'm cautiously optimistic.

• 38:05David Weisburd?

  What's the best economic reason to invest into defense tech?

• 38:09Speaker 00

  I'll table your question for a second and say, I think as an American, it makes a lot of sense to be investing in defense and national security right now. As we talked about, sort of the world order is changing dramatically. And if you want the outcome of that process to be positive for yourself and your kids as an American, I think it makes sense to be putting money to work in this space right now. It doesn't hurt that there's a lot of alpha to be had here. So talk about all the reasons why this market is broken. When you're investing in perfect markets, what you get is beta, right? If the market goes up, everybody does well, but no one's really generating any alpha. Defense is still broken. I mean, it's not as broken as it was five years ago. But that means if you understand how to navigate it, there's still real alpha to be found in this market. So that's one of the reasons to be investing in this space.

• 38:54Speaker 00

  If you understand it, there's real money to be made.

• 38:59Speaker 00

  The other reason is the market size, right? So $2 trillion roughly, let's say, between US allies and partners, defense and intelligence, larger market than most, and a lot more money flowing to it today. And then you look at the macro trends. So you say, we've got potentially a conflict over Taiwan in the next few years with China. We have the war in Iran. You've got the war in Ukraine, which everyone thought, I think, would have wound down by now, but clearly hasn't. All the terror organizations sort of reconstituting themselves in Northern Africa. There's a lot going on in the world, and that is going to drive a lot of demand in the future. Moreover, that demand isn't going to look like what it looked like 10 years ago. It's not aircraft carriers anymore. It's new technology, right?

• 39:44Speaker 00

  So there's a lot to be optimistic about from a financial perspective over the next 10, 20 years.

• 39:50David Weisburd?

  No one that I've talked to, whether in the space or outside of the space, believes that defense budgets are going down over the next decade. I've never heard anyone take the under.

• 39:59Speaker 00

  It's crazy to say we might have a $1.5 trillion defense budget, but I think to put that in perspective, I want to say that'll be like 3.5%, 4% of GDP. I mean, during the Cold War, I think we topped out at like 9% of GDP for defense spending. Towards the end of the Cold War, it was like 6% or 7%. So we're nowhere near historic highs, but the world is sort of in a historic bad spot right now. So there's still a lot of room to run despite the sort of debt problems we have. And then if you are one of the defense bears and you think that the defense budgets aren't sustainable, what I would say to you is even if that is true, even if it's true that we

• 40:40Speaker 00

  can't have $1.5 trillion defense budget every year for the next five years, we can't afford it. The world isn't going to get any safer, and America's security commitments aren't going away. And so the only way to address that, if you're going to cut the budgets, is to cut the programs where you get less bang for your buck. And that is cutting from the programs that are things that we're not investing in. So that's cutting from aircraft carriers and traditional shipbuilding programs. It's cutting from the traditional cruise missile programs and moving more of that budget to things like Androl's cruise missile replacement, the Barracuda. So I think budgets are going to go up. Even if they come down, more money is going to end up going into the sorts of things we're investing in.

• 41:23David Weisburd?

  Old warfare versus new warfare and new technologies.

• 41:27Speaker 00

  That's right.

• 41:28David Weisburd?

  What's the strongest ethical argument for investing in defense tech?

• 41:31Speaker 00

  American ideals are some of the best ideals in the world. I think that we don't always live up to them, but I think that we try to, and that can't be said for everybody out there. And so a strong America is good for the world, and that's a reason to be investing in US defense tech. I also think that investing in defense requires a much more nuanced view of ethics. I'll give you some concrete examples for this. Really, I think any investment is an ethical decision, and we should have more nuanced views of how we put our money to work. But I'll give you three companies. So one company makes missiles.

• 42:12Speaker 00

  One company is an e-commerce company and sells discount goods to folks online. And one company makes drones but won't put a bomb on their drones. Which of those companies is the most ethical company, right? And I think that someone's inclination would be, well, it's probably the e-commerce company. But like, let's talk about these companies and these products more specifically. So the company that makes missiles is Raytheon. They're making SM6 missiles. Those missiles could be shot at ground targets and civilians and kill innocent people, but in fact, they generally are used to shoot down missiles that have been fired at civilian populations. That's how we've used most of them in the last couple of years.

• 42:54David Weisburd?

  Track record of them being used.

• 42:56Speaker 00

  That's the track record, right? So their intent is to protect civilian populations. So is it ethical to buy those missiles or to invest in the companies building them? I would say yes, highly ethical. Those are defensive products, even though they have an offensive use case. That second company making drones, they decided they wouldn't put warheads on their drones. The engineers all got together, they voted, they said, we're not going to weaponize their drones. But they did decide that they would put a laser designator on there. What's a laser designator used for? It's used to guide bombs to their target. So what's the ethical decision here? Like, we won't kill people, but we'll help you kill people. All right, so maybe like the confused ethics.

• 43:34David Weisburd?

  It's almost semantics.

• 43:35Speaker 00

  Right. And then the third company is Timu, right? Came onto the stage, Chinese company, selling really cheap products. I think they've captured something like 50% of the discount online e-commerce market here in the US. Put a lot of mom and pop businesses out of business, has collected a lot of purchasing and personal information on US persons, and is funded partially by the Chinese Communist Party. It is 100% economic warfare against mom and pop businesses here in the US and selling crap products, some of it made by, you know, Uighur slave labor. What's the least ethical business of those three? And I would argue it's Timu, right?

• 44:17Speaker 00

  So I think if you are not even an investor in defense, if you are an investor, you have to think critically about what your money is being used for and what the intent is. And it rarely has to do with the product. It usually has to do with the founders and the company's intent of how their products will be used and how it will influence the world. So that's how we think about it, right? Like, we would never invest in a company where their first market is to go sell missiles to African warlords of dubious intent, right? And we've, in fact, kicked a bunch of companies out of our diligence funnel because of that sort of thinking. But it requires a much more nuanced thought process.

• 44:56David Weisburd?

  To steel man, there's really two arguments or two considerations. One is, I think, a genuine consideration, the humanitarian case and thinking through the nuance of what is the incremental missile doing to society, doing to the world? I think that's a fair conversation to have. I think it shouldn't be had in a vacuum. We don't live in a world that only has one country with one military. The other one, unfortunately, I think, is not necessarily cynical, but is more of an optical question. You could use the word virtue signaling, but an optics question, which is what happens

• 45:36David Weisburd?

  if a student activist in freshman year talks about defense and this creates a memeable idea that the university is investing into defense? That I think is more of an optics consideration, which of course is important to manage, but it's less of an ethical thing. It's more of a self-preservation for the investors and for the investment organizations. It's an economic case, not an ethical case.

• 45:58Speaker 00

  We definitely come across folks where the optics is their biggest concern, right? They don't want to be seen as investing in a company that like, maybe their product someday is misused by somebody, or there's an accident or something, and it finds its way back to them. I would say for those people, if you are interested in the, through the patriotic case for investing in US national security, but you are worried about the optics, there are lots of ways to go about it. Certainly, investing in manufacturing, investing in the sorts of like logistics and sustainment companies that make it possible to build sort of the national security base on top of that here in the States are all ways where you can put your money to work in a patriotic

• 46:42Speaker 00

  way that doesn't expose you to the same kinds of risks. But I would say if you were willing to take those risks, there's return to be had because lots of people aren't willing to take those risks, right? So generally, when you're investing, you want to be putting your money where other people are a little bit afraid to go.

• 46:59David Weisburd?

  Also, on the relative aspect of it, ethics, when you think about American defense, it's unfortunately, defense is more or less a zero-sum industry. And who are the other players? Our main adversaries are China, Iran, and Russia. If you look at the ethics of a Russia invading a neighboring country, or Iran murdering tens of thousands of civilians, or China with a totally authoritarian and no freedom of speech and literally modern day slavery, on a relative basis, America's by no means a perfect country, but on a relative basis, there's no comparison to be had.

• 47:38Speaker 00

  100%. One of the most common fallacies that people fall into is they say, oh, I don't want that to exist, so I'm not going to invest in that, or I'm going to advocate against it, right? I'm going to protest or whatever, which I get. But the option isn't that this thing that you don't like just goes away and then there's no consequences, right? You have to live with the world that we live in and then do what you can to make it better, right? And so in that world, like, defense is an important aspect. Maybe someday, humanity grows beyond needing to build defense products, and all that capital

• 48:19Speaker 00

  through globally can go to climate projects and housing and those sorts of things. But that's just not the world we live in, right? So we can choose to unilaterally disarm, but if we do that, I don't think the world ends up looking better than it does today. I think the world ends up in a pretty bad spot.

• 48:35David Weisburd?

  Think you have underwriting. We've had this evolution where VCs have wanted to go nowhere near defense companies. In fact, most were prohibited by their LPAs. So now, a lot of VCs able to and actively building out teams to go out to the space. What about on the LP side? Have you seen since 2019 LP sentiment towards defense tech and defense-focused venture funds?

• 49:02Speaker 00

  In 2019, 2020, most of the institutional LPs didn't want to touch it with a 10-foot pole. It was kind of funny because they might have had an investment in Androl. But again, when Androl first started, they weren't building sort of things on the kinetic end of the spectrum. They were working sentry towers and stuff like that. So I think some of the institutions were able to get stuff through their investment committee that they might not have been able to get through in 2020, 2021. But yeah, they didn't want to touch anything kinetic for sure, and defense as a category was pretty scary for most institutions. Family offices, it was definitely a mixed bag. You certainly had some patriotic families in there who were interested in the space.

• 49:47Speaker 00

  But no one really believed in the sector from a financial standpoint. So I think most of my early pitches, when we were raising our first fund, was pitching the sector as much as I was pitching our team and our expertise and why we thought that times were changing. Turns out we were right, but not everyone believed us, which is fine.

• 50:07Speaker 00

  Now, I think the institutional LPs, some of them are actively investing in defense, which is great. If they're not actively investing in defense, they're at the stage of we are still thinking about how we're going to approach the market, but they've already decided they're going to approach it, right? So they're trying to figure out how it fits into their portfolio.

• 50:26Speaker 00

  But very few people today are still dead set against it. I will say every once in a while, we come across an institution,

• 50:33Speaker 00

  usually in a, in a blue state, we're a non-political organization, but usually in a blue state, it's a little bit more progressive, where they're managing public funds and they still have requirements or restrictions on investing in certain kinds of defense products. But it's getting rarer and rarer. Even in Europe, their LPs are starting to change the way they approach the sector.

• 50:56David Weisburd?

  You've seen this evolution where first, probably five years ago, LPs would sometimes have to divest from funds that ended up getting exposure to defense companies. Then if they just, something like an Andorl ended up in their founder's fund portfolio, they were fine with that. It wasn't intended consequences. Then it was about, well, it could be defensive warfare, not offensive warfare, and now we could do everything. So there's been kind of almost these four stages.

• 51:22Speaker 00

  It's moved through the spectrum for sure. I can remember, this is only a few years ago, we invested in the seed round of Mock Industries. They disclosed their Series C or valued it, I think around $2 billion now, but we were investing in their seed and I was talking with the founder, Ethan, at a coffee shop. We had already committed and he was telling us that he was evaluating a couple leads at the time, one of which was Sequoia. And I did a thing that I think maybe no VC has ever done until I did it. I tried to convince him not to take money from Sequoia.

• 51:59Speaker 00

  And Sean McGuire over there, who leads the defense investments, is brilliant. He's a friend. I think he does great work. Definitely want him on cap tables. But at the time, Sequoia hadn't divested from their China entity and Sequoia really even couldn't invest in defense. They still had restrictions. But it was for Mock that Sequoia got rid of their own internal restrictions. They had to amend their documents to invest in defense. And then they sort of finished their Chinese divestment. So I'm thrilled now that Sequoia ended up investing in the seed round. But yeah, the industry has just dramatically changed in terms of like how they are willing to approach defense. And then, as I said, whether or not they're willing to take Chinese money or sort of adversarial capital onto

• 52:43Speaker 00

  cap tables, like all that's a work in progress right now.

• 52:46David Weisburd?

  When a defense company gets hot, what are they looking for from their VCs that's unique to defense tech?

• 52:53Speaker 00

  That's a good question. I can only speak for, from our perspective. For us, because this is all we do is defense, earlier in their lifecycle, most companies do not have a really strong round game in DC. So we help out a lot with that. So we spend a lot of time, like I said, there's four committees in Congress that work in defense. We spend a lot of time with those committees and their staff and we help companies sort of build their early congressional engagement strategy and start building up those relationships. So we do a lot of that work. We connect a lot of founders with the right program offices. And program offices are the organizations inside the Department of Defense that make the purchasing decisions. Now they're called program acquisition executives.

• 53:40Speaker 00

  And so the department can be fairly opaque from the outside. So finding the right buyer can be challenging. We help founders with that. So it's a lot of blocking and tackling that we do for founders.

• 53:54Speaker 00

  Early on, and then I would say up through Series A, once they've raised a substantial Series A, most of them start bringing all those functions in-house and paying for it themselves. And the way we do that, which I think is relatively unique to us, and we kind of stumbled into it, it really wasn't an intentional strategy, is we run a fellowship program where we take active duty personnel and government civilians, usually like mid-career to senior, so majors and chronals generally, or like junior political appointees, folks like that, staffers from the Hill, into a mark. We take them into the venture firm. For two months, we basically train them on how to be a mark associate, what we're

• 54:37Speaker 00

  looking for in companies, how we do diligence, how we evaluate founders, what technologies we think are compelling, teach them how venture works generally. We send them back to their A job. We now have 100 alumni out of that program. We do 10 people a quarter. We have, like I said, congressional staffers, folks who run program offices, chronals and generals who all come through this program. They live in our Slack and our Signal. So we actually get a lot of deal flow from these fellows.

• 55:06Speaker 00

  And they help us evaluate companies, but really like the true value is there is no office in the Department of War, Department of Defense, or the intelligence community that is more than one hop from one of our fellows. And so we are able to leverage that network to help our companies find the right person to evaluate a company or a product or a technology.

• 55:28Speaker 00

  All around this like educational program we built, which really we did out of a sort of a patriotic sense that we wanted to give back to the community and also bring a little bit of education about how private markets work. But it's become this like secret weapon for us.

• 55:41David Weisburd?

  What about as companies get larger? How do the top founders pick VCs as these defense companies start to scale?

• 55:50Speaker 00

  It's a great question. We don't generally do growth stage investing, although we do a little work with our LPs to help facilitate that for them when they're interested.

• 56:00Speaker 00

  Andorl is a great example. It's a team, like a founding team of iconoclasts. I think Trey Stevens is on record having said something along the lines of like, they've never had a VC, or maybe with one exception, deliver like the value that was promised at investment. And I think the team there generally is aligned with that thinking. And so they're very skeptical on value add. And so then I'm thinking, when you are picking which investors you want on your cap table,

• 56:31Speaker 00

  it's either those investors are bringing like value in hand, like on day one, you're going to give me some equity in your company and I'm going to deliver some value to you today. So you have to prove it.

• 56:40David Weisburd?

  Almost a pay to play.

• 56:42Speaker 00

  Almost a pay to play, sure. You are just looking for people you want to be sitting around a table with or having a beer with on the weekend.

• 56:48David Weisburd?

  They're not going to provide any value. Who do I want to be around and who do I trust? If you could go back to 2019, give yourself one timeless piece of advice about how you could be better as a defense tech investor, what would that one timeless piece of advice have been?

• 57:02Speaker 00

  Oh, man. So many.

• 57:08David Weisburd?

  You have a couple.

• 57:09Speaker 00

  Yeah. I would have stocked up on whiskey for those like late nights where I'm just like sitting in a dark corner crying. The government does so many things that like feel personal and just like screw with your life.

• 57:23Speaker 00

  And I've since like realized that it is not personal. It's just the machine grinding away. But there were a couple of years there where it felt very personal. And so I had some just bad days. Things were like, you get an email and you're asked to apply to a program, right? They've got an RFP out, they want some folks to do some things. And then you do it and then you don't get selected for the program. And it's like, well, why did you email me and ask me to spend a week of my time and my team's time to do this? And then it's very personal, right? But it's not personal. It's just the machine grinding away. So understanding that, I think would have like helped my mental health a little bit earlier on.

• 58:00David Weisburd?

  Made you push through those time?

• 58:02Speaker 00

  Because when it's not a bad day, it's a great day. The team that we have, I just love working with them every day. I wouldn't tell my LPs this. I guess I will tell my LPs this. I would do what I do for free, if I could afford to do it for free, for sure. I just love it. I get to play with cutting edge technology, work with mission-driven founders who like really care about the problems they're trying to solve. I get to be part of a bigger mission and sort of like live my family heritage.

• 58:32David Weisburd?

  Your family has roots going back to the American Revolution.

• 58:36Speaker 00

  My grandma was in Adams, but goes back to John Quincy and John. Every man in my family, all the way back is fought in essentially every American war. As a kid growing up, like probably a lot of kids of my generation, I wanted to be a fighter pilot because I watched Top Gun and he doesn't want to fly F-14 Tomcats.

• 58:56Speaker 00

  But I was fat and uncoordinated as a child and I was told by my family that I should go to law school.

• 59:02David Weisburd?

  One of the consistent patterns in all great entrepreneurs, especially these category creators like Palmer Lucky from Andorl or Elon Musk from SpaceX, is that they're almost by definition early. And it's understanding that when you're early, you're either super early, you might be five to seven years early and then you're kind of out of luck. But you might be one to two years early. Suffering is the sign that you may be on to something extremely lucrative.

• 59:31Speaker 00

  It's true. I mean, you asked like what lessons or what advice I'd give myself and there's lots of advice, but I would never change anything, right? Like there's that sort of like that dinner party question, like what would you change if you could go back in time? I'd never change anything. Like I love where I am in my life and what I do. And there were lots of painful moments, but I worry if I changed those painful moments, I wouldn't be where I am today, right? So literally I'd change nothing.

• 59:56David Weisburd?

  Alex Hermosy has been on the podcast twice, one of my favorite guests. He has a saying that you don't work on the business, the business works on you. And sometimes it just takes that suffering, that pain is what actually forms you as an individual.

• 1:00:10Speaker 00

  Hundred percent agree.

• 1:00:14David Weisburd?

  Five, 10 years from now, is there an optimistic view of the future of defense tech?

• 1:00:19Speaker 00

  Definitely an optimistic view of the future of the industry. Like we talked about, like the macro trends are sort of bad for global stability, which is good for this industry. Actually, one of the reasons I think it makes sense to invest in defense is it's pretty counter cyclical. So it's just a good piece to have in your portfolio. But

• 1:00:36Speaker 00

  the broader question, like do I have an optimistic view of the world? And the answer to that is definitely yes. And actually, as I said earlier, I got into investing, doing deep tech investing. And then from there, really got into national security. The reason I was doing deep tech investing is I was inspired by Gene Roddenberry and Star Trek. And I was like, why, why invest in apps or consumer goods? Like when I can be investing in something like really trying to drive humanity forward, towards that like post-economic vision that Gene Roddenberry had, right? Really, I think Star Trek is a whole separate topic. And I think Star Trek is really an allegory for like self-actualization, right? Like basically,

• 1:01:17Speaker 00

  technology has made it such that everyone in the Federation can be an explorer. And sometimes it's literally an explorer on the Starship Enterprise and sometimes it's an explorer more metaphorically in terms of doing research and writing and that kind of stuff. A beautiful vision for humanity and I think it's one that's, it's possible and enabled by technology. So like macro, I think I'm very optimistic. Over the next like five to 10 years for the world, I think we still have a lot of disruption that needs to shake out.

• 1:01:47David Weisburd?

  On that note, thanks so much for jumping on. Absolute masterclass on defense. Looking forward to doing this again soon.

• 1:01:53Speaker 00

  Thanks for having me. This has been fun.

• 1:01:55David Weisburd?

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