VC investors step into defense tech with limited visibility

Venture capital investors have been citing reduced red tape and the Golden Dome as major drivers of their leap into defense tech.

Yes, but: Obstacles remain when the U.S. government collides with Silicon Valley.

Behind the scenes: Most VCs lack the clearances necessary to access classified information — limiting visibility into their investment.

• In board rooms, it's not uncommon for a member to excuse themselves when details relating to a major contract emerge.
• "We hosted a defense tech dinner in D.C., and people asked, 'Do you have clearance? 'And I say no, and they say: 'Well, I can't tell you this, but I'll speak about it in the abstract," says Michael Brown, managing partner of Battery Ventures.

That has implications for the due diligence process.

• Investors still see the overall finances of a business, but might not see the technical specifications of a product tied to a classified project.
• In one case heard by Axios, a company could not reveal when a major payment hit, as it risks signaling a highly watched product has successfully been completed.

Between the lines: As record-high dollars flow into the sector, the big question is if investors without clearances have enough information to make investment decisions.

• Most investors I spoke to believe the information flow is adequate, noting that not all defense tech deals have highly classified information or are wholly dependent on the government for revenue.
• DCVC's Matt Ocko argues clearances will be an edge for investors as the industry dives deeper into critical, and likely sensitive, tech. "You're not getting ground truth," he says. "If there is a new nation-state actor or threat, you can't tell if your company is viable anymore or if you have the golden ball of 'unobtanium'."

Zoom out: "In the defense tech world, there's this overlapping weave of regulatory regimes," says Joshua Gruenspecht, a partner of Wilson Sonsini.

• Companies with foreign investors not only file with CFIUS, but they may also face further scrutiny from the Defense Counterintelligence and Security Agency (DCSA) if they handle classified information. And while a foreign investment may not be an issue with the CFIUS, it could be a problem for DCSA.
• The constant transition from one administration to the next has led to more self-policing by companies, says Holland & Knight partner Robert A Friedman.
• "I've seen people turn down eight-figure amounts," Gruenspecht says, with companies aiming to avoid any conflict with the DCSA. "Scrutiny on FOCI (Foreign Ownership, Control, or Influence) has increased meaningfully. "

Case in point: Allen Control Systems, an autonomous-turret maker, says it's purposely not taken foreign investments of any kind to avoid slowdowns in the contracting process.

The bottom line: Defense tech is not for the faint of heart.