To Keep Up, We Must Startup
Supporting U.S. innovation has become a key national security priority, as demonstrated by year-over-year increases in technology research and development (R&D) spending and the Senate's passage yesterday of the CHIPS and Science Act of 2022.
Yet for all the hype around technology acceleration and protection, the U.S. faces a paradox: The funding source that matters most is drying up.
Venture capital (VC) funding is the backbone of many companies, particularly those in early stages. Over the course of a decade, investors poured $1.3 trillion into promising startups, enabling many companies to achieve billion-dollar valuations. In 2021 alone, VCs supported over 14,400 companies across the United States in 414 Congressional Districts. This also makes them a major source of employment, as evidenced by the 8x larger growth rate in jobs for VC-backed companies compared to non-VC-backed companies between 1990 and 2020.
But many VCs are rethinking their approach to risk-taking, which is reflected in crashing tech stocks that are exacerbated by rising inflation and interest rates. Instead of funding company growth initiatives, such as building proof-of-concepts and hiring, VCs are scrutinizing return-on-investment (ROI) earlier in the investment cycle, such that job losses have reached a two-year high and companies like Coinbase have rescinded offers. This has even affected the cybersecurity sector, which could have been viewed as an area of resilience for tech investments, given nationwide attention on the increased frequency and sophistication of ransomware attacks.
Today’s economic conditions make it easy to understand an investor’s position; a crashing stock market isn’t ripe for risk-taking. This mindset extends to employees, who will likely start seeking employment at Big Tech companies due to the job stability bigger companies offer.
However, as the U.S. focuses on strengthening its innovation base — including through the U.S. government’s increased cooperation with the private sector and acquisition of commercial technologies — it must pay attention to VC risk-taking trends, which are essential to producing the technologies at the speed and scale required to outcompete China.
Simply put, risk-taking fuels innovation, which is why startups are where innovation thrives. Key to their success is having room to fail, which is validated by interaction with potential customers. This is particularly true for early-stage companies that are gaining name recognition and/or pursuing technologies that are still evolving in the market, such as applications of artificial intelligence and advancements in quantum computing. Consequently, requiring companies to demonstrate ROI earlier inhibits their ability to test and build out innovative ideas, and the resulting decrease in VC funding only increases their likelihood of failure.
Reduced VC funding also inhibits a company’s ability to attract and retain the best talent. Smaller companies now struggle to offer competitive employee packages because they need the cash on hand, and the tech market crash makes equity value questionable. At a time when demand for tech talent continues to soar, it is ironic to see these hiring struggles and layoffs, both of which impact the worker morale that inspires innovation.
The U.S. government cannot and should not dictate how VCs invest their money. However, recognizing the risk reduced VC funding poses to U.S. innovation, the U.S. now has the opportunity to create conditions that support VC risk-taking.
The Administration can start by providing clearer guidance on its priorities for technology investments. Currently, the White House Critical and Emerging Technologies list comprises 19 areas deemed important to national security, all of which contain subfields. While they are all significant, there are too many for VCs to determine which technologies are the best near- and long-term investments. Prioritizing this list would create a better demand signal for VCs, which would help them focus their investments and decrease their sense of risk. Focused funding will not only accelerate the pace of innovation, but also align investments with U.S. strategic objectives.
Additionally, the U.S. government must focus on increasing and improving funding opportunities for promising startup companies that fill key national security-related technological needs. Congress can start by using the current SBIR/STTR reauthorization debate to identify and address weaknesses in the programs (such as ties to China, for which they are rightly being scrutinized), define their intent, and improve processes. This way, the U.S. can continue to support American innovation and provide an ROI demonstration opportunity for companies seeking VC investment, while protecting U.S. technologies from authoritarian regimes.
America’s innovative spirit is what enabled Silicon Valley to become a model for the world, and it is a strategic advantage that the U.S. must maintain. Keeping up in the race for technology means ensuring startups have access to the VC funding they need to succeed.
Alexandra Seymour is an associate fellow of the Technology and National Security program at the Center for a New American Security.
