The Army as Venture Capitalist: An Innovative Approach to Funding Research and Development
The United States Army is having difficulty balancing its need for new technologies with the resources available to develop them. The Army currently faces the challenge of finding better methods for developing the new technologies needed to stage its revolution in military affairs (RMA) while keeping current equipment relevant and affordable. RAND researchers recently introduced a novel solution: that the Army should fund some of its technology development through a private venture capital organization.
Over the last few decades, venture capital has emerged as a financial engine for the new technologies and industries that are changing the world. RAND analysis shows that not only would an Army venture capital fund help reinvigorate research and development (R&D) in the defense industry; it could also help the Army leverage outside resources, like co-investors, that would allow it to stretch its own R&D resources. In addition, revenue returned on the Army's venture capital fund investments could be used to re-invest in more new technologies.
What Is Venture Capital?
Venture capital organizations provide a financing source for start-ups or emerging companies that have a concept, a plausible market, and a business plan but lack the resources necessary to develop and market their ideas. By investing in these new businesses, venture capitalists accept a greater-than-average investment risk for the short term but potentially reap higher long-term returns than they would from other investments.
Venture capitalists typically receive an equity stake in the funded business and usually provide management and business expertise to the businesses they are backing. Although venture capital is a relatively young concept, it has been extremely successful in developing and exploiting innovation. Companies such as Intel, Apple, FedEx, and Netscape used venture capital as a key resource and are examples of its success.
The reasons for venture capital's success are its inherent incentives and an organizational structure that helps innovative ideas develop. Businesses that venture capitalists back tend to be young, small, and growth-oriented. Company founders tend to be risk-takers who are motivated by their vision. Investors are experienced businessmen and businesswomen who know how to manage young companies and commit a significant amount of ideas, experience, and time to the companies they back.
Could the Army take advantage of the incentive and organizational structures that make venture capital such an engine of innovation? RAND researchers believe that ample evidence exists to suggest that it could, and they present many compelling reasons why the Army should consider a venture capital fund.
The Rationale for a Venture Capital Fund
Even Large Corporations Use Venture Capital Funds. Researchers studied large corporations such as Xerox, Microsoft, and Lucent Technologies. Even though these companies have substantial R&D capabilities, they recognize the benefits of venture capital and now use it to develop technologies for their businesses. These examples are important when considering whether a venture capital model will work for the Army. They suggest that even large organizations with organic R&D capabilities have found venture capital to be an efficient use of limited R&D resources.
Venture Capital Is Spreading to the Public Sector. Researchers studied the Central Intelligence Agency's (CIA) In-Q-Tel enterprise and considered it to be the example closest to that envisioned for the Army. The CIA established In-Q-Tel about a year ago to solve some of its most difficult information technology problems, and venture capital is one of the tools In-Q-Tel uses to address the CIA's needs. Though it is only about a year old, In-Q-Tel appears to have made a very promising start.
Army Venture Capital Can Better Access Commercial Technology. A growing portion of technical innovation occurring in the United States is happening in the commercial sector, thus making Army access to that sector more important than ever. Army leadership, recognizing the importance of tapping the commercial technology sector, has emphasized its desire to increase collaboration with commercial technology developers. Unfortunately, the Army's traditional contracting methods make this difficult. A venture capital organization could circumvent some of the Army's problems in trying to collaborate with the commercial sector. The Army venture capitalist could act as a middleman who understands the needs of the business and technology communities. He/she could shape agreements that solve Army technology problems while also meeting those needs.
Venture Capital Can Leverage Non-Army Resources. Today, most Army research is conducted exclusively with Army resources. Assuming the Army's fund invests in technologies with commercial potential, it is likely to be able to attract significant co-investment. The Army can thus stretch its own R&D resources so that it can accelerate the development of key technologies while also continuing to invest in a wide range of new ideas.
Venture Capital Provides a Return on Investment (ROI). As mentioned earlier, venture capitalists expect large returns as compensation for their investment risks. Most of the technologies appropriate for investment by an Army venture capital fund will have a longer term commercial potential. By using a venture capital model to make the initial investments in new technologies, the Army will be able to earn a ROI as the commercial market for these technologies grows.
Venture Capital Helps Give Rise to Entire Industries. In its short history, venture capital has become the source of start-up money for many emerging industries. In the military, many transforming technologies, such as repeating rifles, radio, and aircraft, have also spawned new industries. Since most R&D is currently taking place in the commercial sector, many of tomorrow's transforming technologies are being developed with little input from the military. By creating its own venture capital fund, the Army can regain some of its access and influence in emerging industries.
Researchers Propose a Possible Implementation Strategy
Researchers tentatively call the potential fund the Army Innovation Investment Corporation (AIIC). They recommend that AIIC be managed by a Board of Directors whose members are private citizens selected by the Secretary of the Army for staggered 2- to 3-year terms. The AIIC could be incorporated as a not-for-profit corporation under the jurisdiction of some state or incorporated by Congress under a federal charter.
An estimated $2 million would be required to set up the AIIC, and researchers suggest that approximately $30 million be budgeted to the AIIC every year in its first five years of operations. Beyond the initial five years, the AIIC, if successful, should be self-sustaining with an investment portfolio averaging $150 million.
Researchers recommend that the staff contain a mix of personnel with business, technology and government personnel. This eclectic group must then be integrated by a strong leader who understands not only the complexity of technologically oriented business deals, but who can also navigate the political and bureaucratic terrain inherent in an organization of this type.
An Army Advisory Committee composed of personnel from the Army Materiel Command (AMC), the Office of the Assistant Secretary of the Army for Acquisition, Logistics and Technology (ASA(ALT)) and the Training and Doctrine Command (TRADOC) would form the interface between the Army and the AIIC. The committee would be responsible for communicating the operational requirements and technical needs of the Army to the AIIC. The AIIC, however, would make all business decisions concerning investments. The Advisory Committee would also be responsible for the transfer of technical information from the AIIC back to the Army.
The structure of the venture capital industry encourages innovation and provides entrepreneurs the tools they need to develop and market their ideas. Since the Army is increasingly dependent on advanced commercial technologies, it seems natural for it to consider adopting a venture capital model for some of its technology development. Such an approach has been successful for other large, technically oriented organizations and has also proved successful with other government entities.
Use of a venture capital model for development of relevant advanced technologies could significantly help the Army achieve the acquisition reform goal of affordably acquiring the leading-edge technologies it needs.