Welcome back, and thanks for your continued support and engagement! This week, we highlight a couple lists - SVDG’s NatSec 100 and Defense News’ Top 100 - to compare and contrast and see if there’s any alignment between venture-backed firms with traditional primes. We discuss a report that concludes China is outpacing the US in critical technologies (by patent filings), but also gives a nice summary of how the government invested in those segments, 2017-2022.

This week’s post:

• 📃 Top 100 Lists

• 💰 Term Sheet

• 🚩 Red Team Update

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Top 100 Lists

August is traditionally a slow month in finance as everyone vacates for their annual retreat to Europe or the Hamptons, but defense never stops. The Silicon Valley Defense Group (SVDG) published its inaugural National Security 100 list, ranking the top 100 venture capital backed defense and dual-use startups. Yesterday, Defense News published its Top 100 Defense Companies, which ranks companies around the world based on their defense revenue.

While there are no shortages of top lists, SVDG’s and Defense News’ Lists are spurring discussion and enthusiasm around global defense markets. SVDG’s list focuses on emerging technology, while the Top 100 Defense Companies by defense revenue does not include any of the emerging defense tech unicorns such as Anduril or Shield AI.

Silicon Valley Defense Group - NatSec 100 List

The late Senator John McCain sought to establish an organization that bridged the gap between Silicon Valley and government. Senator McCain’s message to DoD was that more and more technology innovation that the US military will need was being developed by commercial firms, and the US must adjust to this new reality. After the late Senator met with the eventual founders of SVDG, the non-profit was formed with the mission of aligning and connecting people, capital and ideas across government and Silicon Valley. One way to connect people and ideas in defense tech is create a top 100 list that is discussed in newsletter communities such as Arsenal of Tomorrow.

The top-tier startups on this year’s NatSec100 have raised an impressive $42Bn in funding. From AI to space technology, these startups are reshaping defense. Despite the $42Bn in funding, the revenue generated from these companies from DoD and the federal government currently stands between $2 and $5Bn.

NatSec 100 (Top 25):

1. SpaceX - $9.0Bn (Total Funding Raised)

2. Anduril - $2.3Bn

3. Databricks - $3.5Bn

4. Sierra Space - $1.4Bn

5. Chainalysis - $536M

6. Axiom Space - $274M

7. Relativity - $1.3

8. Grafan Labs - $569M

9. Shield AI - $575M

10. Dataiku - $851M

11. Skydio - $644M

12. Scale AI - $603M

13. ICON - $451M

14. Lyten - $210M

15. SandboxAQ - $500M

16. Dragos - $358M

17. Slingshot Aerospace - $81M

18. Venus Aerospace - $48M

19. DataRobot - $1.0Bn

20. Ursa Major - $286M

21. Rubrik - $1.1Bn

22. Versa Networks - $330M

23. ThoughtSpot - $677M

24. PsiQuantum - $665M

25. Capella Space - $284M

SVDG does warn in its report that the continued discrepancy between funding and revenue generated from the government could lead to investors leaving the defense sector without additional substantial government contracts. As it stands now, the DoD and intelligence community do not provide consistent contract awards that would fuel growth.

Lack of contract awards for these startups could have far-reaching consequences for national security and even some dual-use technology markets. China has embraced the commercial and military innovation strategy through its inherent civil-military fusion, which helps accelerate China’s speed of innovation adoption.

Methodology

SVDG compiled the top 100 list in collaboration with Franklin Templeton Private Equity Firm and Balyasny Hedge Fund. The list takes into account the 14 critical technology areas from the Office of the Under Secretary of Defense for Research and Engineering.

The majority of companies in SVDG’s list specialize in space tech and AI. We discussed this very trend in the 1H 2023 VC Investment Rollup last week, here.

The key investors breakdown is another interesting view inside emerging defense tech. The government-backed In-Q-Tel is the most prolific investor, yet at smaller amounts per investment.

Lastly, the deal count since 2016 has risen considerably with a peak in 2021 and potentially a return to 2018-2019 levels in 2023 (data as of April 2023):

In 2022, SpaceX and Anduril had the two largest fundraises in all of venture capital, receiving $1.97Bn and $1.48Bn, respectively.

Deal count peaked in 2021, with 97 startups on the NatSec100 receiving a total of $16Bn. In 2022, 69 startups on the list received a total of $9Bn.

If you remove SpaceX and Anduril outliers, there’s a decline in total capital raised by the remainder of the NatSec100 list. Policymakers should think about how 2021 investments were spurred on by low interest rates, post-covid 19 macro tailwinds, but going forward in 2022 and 2023, the market has not been nearly as robust. Government contract wins will be the key deciding factor for these startups on SVDG’s NatSec top 100 list.

Defense News’ Top 100 for 2023

Not to be outdone, Defense News published its Top 100 list yesterday. The list curiously does not include any of the NatSec Top 100. Instead, it’s dominated by prime defense contractors such as Lockheed Martin, Boeing, Northrop Grumman, General Dynamics, BAE Systems, and RTX (formerly known as Raytheon Technologies). While a list of global defense companies sorted by revenue is expected to be dominated by the primes, it is surprising that Anduril or Shield AI did not make the list at all.

The list has an aggregate of $534Bn in FY22 defense revenues which is a decline of 10% from $595Bn recorded in FY21. Nearly 56% of all defense revenues in FY22, or $298Bn, went to the largest 10 defense firms. The remaining $238Bn is shared by the 90 remaining companies. Anyone that pays attention to the defense industry has noted DoD and other government figures stating how we need to diversify the defense industrial base. An easy way to do that would be awarding sustained commitments to the venture-backed companies discussed above.

Today, a defense startup has almost no or very little chance to lead a major, multibillion-dollar program. Those programs will only go to the primes, but as the bottom of the Top 100 list experiences churn and the Andurils and Shield AIs of the world climb their way into the mix, the odds increase that a prime could one day be unseated with an awarding of a major defense program. The emerging technology verticals such as autonomous wingman, combat collaborative aircraft, unmanned surface maritime vessels and software will be key opportunities for a smaller company to climb the list tomorrow.

Lockheed and RTX led this year’s Top 100 list and remained unchanged in the number 1 and 2 slots, respectively. Boeing dropped from 3rd last year to 5th this year due to a 12% drop in its defense revenues from fixed price contracts issues such as the T-7 Red Hawk USAF Training Fighter to replace the aged T-38 Talon.

A major problem with disrupting the primes is the military / senior government official exit path to defense primes. A report by Project on Government Oversight titled “Brass Parachutes” found that in FY16, 645 former senior government officials, military officers, lawmakers, senior legislative staff as lobbyists, board members or senior executives were hired by the top 20 defense contractors, with almost 50% of those hires going to the five largest defense primes.

DoD has long said we need to diversify the industrial base. Byron Callan of Capital Alpha Partners said it best, “If DoD does not put real money behind [fostering more diversity in the industrial base] - as soon as the FY25 budget proposal - the investors some smaller companies rely upon will start to look elsewhere.”

Both SVDG and Defense News lists have brought up a good discussion around diversifying the industrial base and funding emerging venture-backed defense startups. We’ll see if policymakers and DoD will listen to these discussions and do something about it. The lucrative pay and brass parachutes from the primes tells us we may be waiting a while.

Red Team Update

Kim Jong Un just showed off two new North Korean aircraft that look shockingly similar to US military drones

• China and Russia joined Kim Jong-Un at North Korea’s “Victory Day” parade celebrating the 70th anniversary of the “end” of the Korean War (the Korean Armistice Agreement was signed 70 years ago and led to the DMZ but is not a peace treaty). It’s the first visit by a Russian Defense Minister since 1991 and first for China since covid-19 began. It’s also the first parade to feature two drone models (including a flyover) among the usual flow of missiles.

• The drones look remarkably similar to a US MQ-9 Reaper and RQ-4 Global Hawk, two systems which were used widely during the Global War on Terror. General Atomics’ MQ-9 Reaper is flown with varying ordnance loadouts for attack missions, while Northrop Grumman’s RQ-4 Global Hawk is used for long-endurance intelligence, surveillance, and reconnaissance (ISR) missions.

• It’s not immediately clear what Jong-Un’s motivations in developing the drones are, aside from general force modernization. Some have speculated that they could be developed for foreign customers, but North Korea has scrambled drone across the border into South Korea in the past. They could also be intended to show increased military readiness and capability, but their utility on the Korean peninsula is likely limited due to their vulnerability to modern air defenses.

US falling behind China in tech advancements, Govini report finds

• Critical technology patents issued to China have increased, while US patents over the same period (2017-2022) had stagnated. This is one indicator of future technological dynamism and could be evidence of the US technological edge further eroding, according to Govini. Govini is a commercial data company whose mission is to advance U.S. competitiveness through dynamic data and machine learning.

• The leading technology area by investment was biotechnology, nearly doubling from $60.7Bn to $117.2Bn over the period. But that’s a bit misleading as lots of government capital was poured into the sector during the covid-19 pandemic. Interestingly, the only segment that stayed flat during the period was space technology.

• The top five segments over the period, in order:

  1. biotechnology ($160.1Bn)

  2. space technology ($67.8Bn)

  3. computing & user interfaces ($56.1Bn)

  4. AI/ML & autonomy ($50.0Bn)

  5. advanced communications ($30.9Bn)

About Us

Our team has 30+ years of combined experience as military officers using the end products. We’ve worked in both government and industry. From MIT to Wharton, Wall Street to biotech, and DARPA to the flightline, we offer you a unique perspective on how to navigate America’s defense tech industry.

The opinions expressed in this newsletter are solely those of the authors and do not necessarily reflect the views of DoD, our employers or any affiliated organization. This newsletter is for informational purposes only and is not intended to provide legal, financial or professional advice.