Space Investing: Costs & Benefits of Public Sector Contracts

General Industry Trends
April 1, 2013
Author
Joe Landon
April 1, 2013
Author
Joe Landon

Space investing: For a fledgling NewSpace startup bootstrapping its way to success, a government contract can provide much needed cash flow and early market validation for a company’s technology. Entrepreneurs leading companies tracked on NewSpace Global’s NSG 100 Index, from Jeff Greason of XCOR to Jonathan Goff of Altius Space Machines to John Carmack of Armadillo Aerospace, are wooed semi-annually by an alphabet soup of public sector monies. In other words, they are lured by SBIRs (Small Business Innovative Research), STTRs (Small Business Technology Transfer) and NIACs (NASA Innovative Advanced Concepts) from the likes of NASA, DARPA (Defense Advanced Research Projects Agency) and the DoD (The Department of Defense). However, for early-stage investors, is there a “dark side” to working for the government so early in a company’s life?

The benefits of landing a government contract are numerous. Government research and development contracts can be a boost to the balance sheet without busting the cap table. “It’s non-dilutive capital that usually pays for the things you’d use investor capital to develop anyways,” according to Jon Goff, CEO of ASM and co-founder of Masten Space Systems. Goff’s company worked early on with DARPA to demonstrate its “Sticky-Boom” technology. Active NewSpace investor and Space Angels Network Founding Member Ed Tuck also sees government contracts as a way to answer one of the key questions about a new company: “Is someone going to buy their product?” Government agencies can tolerate more risk than many commercial customers, resulting in the government often leading the way as a first customer for new cutting-edge technologies.

Having the government as a customer is one thing, but having the government as your only customer – i.e. a monopsony – is another. Dan Mindus, also a member of Space Angels Network, points out that “no business wants to be dependent on a single customer,” and he sees the government as “particularly challenging.” Government agencies tend to have long sales cycles and, perhaps most importantly, government deals often don’t scale commensurate with the returns expected by investors with capital at risk.

Investors and successful entrepreneurs alike give one piece of advice consistently regarding government contracts: don’t get addicted. Ed Tuck has seen companies get bogged down by government contracts. “[A government contract] consumes a small company’s attention, because it takes resources, and the company usually has to add accounting and staff to take care of the unusual way the government does its accounting.” Jon Goff admits that once you have cracked the code for how to write a good government proposal, it’s hard not to get hooked.

Both of these observations are consistent with a management theory penned by strategy guru Clayton Christensen, known as the Resources, Processes and Values framework that warns about matching a company’s capabilities to its goals. According to Christensen’s simple but elegant theory, a company only gets good at the things that it actually does. A company whose only customer is the government gets really good at serving that customer and perpetuating the situation, often to the disappointment of early-stage investors hoping to see rapid growth, innovation, and high returns.

Depending on their structure, government contracts can have limited upside. A “Cost-Plus” contract, one such contracting mechanism, reimburses companies for their costs and provides a fixed profit margin. Operating under this type of regime exclusively for too long can permanently alter a company’s cost structure, making it uncompetitive in the commercial market. If entrepreneurs are not careful, their high growth startup could end up evolving into the dreaded industry colloquialism, “an SBIR Shop” living from contract to contract with little hope of making it big. Such government dependence can be traumatizing to companies, as proven by the still hemorrhaging United Space Alliance, and the series of sellings, downsizings, and mergers between companies like United Technologies and Rockwell International, all as a result of the retiring of the Shuttle program.

Large public companies like Boeing and Lockheed Martin are also susceptible to bloated cost structures resulting from doing too much government work, and this phenomenon created an opportunity that Elon Musk exploited with SpaceX. SET created its own vertically integrated cost structure, free from the influence of decades of government cost-plus contracts, resulting in a more cost-competitive product. SET then went on to win several government contracts, but with its fundamentally lower costs structure, it also attracted commercial customers for a more balanced mix of buyers.

Winning a non-dilutive government contract that provides cash, validation, and a reference customer will delight investors in the short term, but it is a mixed blessing. The paradox entrepreneurs face with government contracts can be resolved with careful planning. Keeping the business on its high-growth path must remain a top priority. Ultimately, a company’s structure and culture must remain at its core, capable of rapid innovation required for lasting success in commercial markets.

This article appeared in the April 2013 edition of NewSpace Global’s Thruster market analysis report.

Space investing: For a fledgling NewSpace startup bootstrapping its way to success, a government contract can provide much needed cash flow and early market validation for a company’s technology. Entrepreneurs leading companies tracked on NewSpace Global’s NSG 100 Index, from Jeff Greason of XCOR to Jonathan Goff of Altius Space Machines to John Carmack of Armadillo Aerospace, are wooed semi-annually by an alphabet soup of public sector monies. In other words, they are lured by SBIRs (Small Business Innovative Research), STTRs (Small Business Technology Transfer) and NIACs (NASA Innovative Advanced Concepts) from the likes of NASA, DARPA (Defense Advanced Research Projects Agency) and the DoD (The Department of Defense). However, for early-stage investors, is there a “dark side” to working for the government so early in a company’s life?

The benefits of landing a government contract are numerous. Government research and development contracts can be a boost to the balance sheet without busting the cap table. “It’s non-dilutive capital that usually pays for the things you’d use investor capital to develop anyways,” according to Jon Goff, CEO of ASM and co-founder of Masten Space Systems. Goff’s company worked early on with DARPA to demonstrate its “Sticky-Boom” technology. Active NewSpace investor and Space Angels Network Founding Member Ed Tuck also sees government contracts as a way to answer one of the key questions about a new company: “Is someone going to buy their product?” Government agencies can tolerate more risk than many commercial customers, resulting in the government often leading the way as a first customer for new cutting-edge technologies.

Having the government as a customer is one thing, but having the government as your only customer – i.e. a monopsony – is another. Dan Mindus, also a member of Space Angels Network, points out that “no business wants to be dependent on a single customer,” and he sees the government as “particularly challenging.” Government agencies tend to have long sales cycles and, perhaps most importantly, government deals often don’t scale commensurate with the returns expected by investors with capital at risk.

Investors and successful entrepreneurs alike give one piece of advice consistently regarding government contracts: don’t get addicted. Ed Tuck has seen companies get bogged down by government contracts. “[A government contract] consumes a small company’s attention, because it takes resources, and the company usually has to add accounting and staff to take care of the unusual way the government does its accounting.” Jon Goff admits that once you have cracked the code for how to write a good government proposal, it’s hard not to get hooked.

Both of these observations are consistent with a management theory penned by strategy guru Clayton Christensen, known as the Resources, Processes and Values framework that warns about matching a company’s capabilities to its goals. According to Christensen’s simple but elegant theory, a company only gets good at the things that it actually does. A company whose only customer is the government gets really good at serving that customer and perpetuating the situation, often to the disappointment of early-stage investors hoping to see rapid growth, innovation, and high returns.

Depending on their structure, government contracts can have limited upside. A “Cost-Plus” contract, one such contracting mechanism, reimburses companies for their costs and provides a fixed profit margin. Operating under this type of regime exclusively for too long can permanently alter a company’s cost structure, making it uncompetitive in the commercial market. If entrepreneurs are not careful, their high growth startup could end up evolving into the dreaded industry colloquialism, “an SBIR Shop” living from contract to contract with little hope of making it big. Such government dependence can be traumatizing to companies, as proven by the still hemorrhaging United Space Alliance, and the series of sellings, downsizings, and mergers between companies like United Technologies and Rockwell International, all as a result of the retiring of the Shuttle program.

Large public companies like Boeing and Lockheed Martin are also susceptible to bloated cost structures resulting from doing too much government work, and this phenomenon created an opportunity that Elon Musk exploited with SpaceX. SET created its own vertically integrated cost structure, free from the influence of decades of government cost-plus contracts, resulting in a more cost-competitive product. SET then went on to win several government contracts, but with its fundamentally lower costs structure, it also attracted commercial customers for a more balanced mix of buyers.

Winning a non-dilutive government contract that provides cash, validation, and a reference customer will delight investors in the short term, but it is a mixed blessing. The paradox entrepreneurs face with government contracts can be resolved with careful planning. Keeping the business on its high-growth path must remain a top priority. Ultimately, a company’s structure and culture must remain at its core, capable of rapid innovation required for lasting success in commercial markets.

This article appeared in the April 2013 edition of NewSpace Global’s Thruster market analysis report.

Space investing: For a fledgling NewSpace startup bootstrapping its way to success, a government contract can provide much needed cash flow and early market validation for a company’s technology. Entrepreneurs leading companies tracked on NewSpace Global’s NSG 100 Index, from Jeff Greason of XCOR to Jonathan Goff of Altius Space Machines to John Carmack of Armadillo Aerospace, are wooed semi-annually by an alphabet soup of public sector monies. In other words, they are lured by SBIRs (Small Business Innovative Research), STTRs (Small Business Technology Transfer) and NIACs (NASA Innovative Advanced Concepts) from the likes of NASA, DARPA (Defense Advanced Research Projects Agency) and the DoD (The Department of Defense). However, for early-stage investors, is there a “dark side” to working for the government so early in a company’s life?

The benefits of landing a government contract are numerous. Government research and development contracts can be a boost to the balance sheet without busting the cap table. “It’s non-dilutive capital that usually pays for the things you’d use investor capital to develop anyways,” according to Jon Goff, CEO of ASM and co-founder of Masten Space Systems. Goff’s company worked early on with DARPA to demonstrate its “Sticky-Boom” technology. Active NewSpace investor and Space Angels Network Founding Member Ed Tuck also sees government contracts as a way to answer one of the key questions about a new company: “Is someone going to buy their product?” Government agencies can tolerate more risk than many commercial customers, resulting in the government often leading the way as a first customer for new cutting-edge technologies.

Having the government as a customer is one thing, but having the government as your only customer – i.e. a monopsony – is another. Dan Mindus, also a member of Space Angels Network, points out that “no business wants to be dependent on a single customer,” and he sees the government as “particularly challenging.” Government agencies tend to have long sales cycles and, perhaps most importantly, government deals often don’t scale commensurate with the returns expected by investors with capital at risk.

Investors and successful entrepreneurs alike give one piece of advice consistently regarding government contracts: don’t get addicted. Ed Tuck has seen companies get bogged down by government contracts. “[A government contract] consumes a small company’s attention, because it takes resources, and the company usually has to add accounting and staff to take care of the unusual way the government does its accounting.” Jon Goff admits that once you have cracked the code for how to write a good government proposal, it’s hard not to get hooked.

Both of these observations are consistent with a management theory penned by strategy guru Clayton Christensen, known as the Resources, Processes and Values framework that warns about matching a company’s capabilities to its goals. According to Christensen’s simple but elegant theory, a company only gets good at the things that it actually does. A company whose only customer is the government gets really good at serving that customer and perpetuating the situation, often to the disappointment of early-stage investors hoping to see rapid growth, innovation, and high returns.

Depending on their structure, government contracts can have limited upside. A “Cost-Plus” contract, one such contracting mechanism, reimburses companies for their costs and provides a fixed profit margin. Operating under this type of regime exclusively for too long can permanently alter a company’s cost structure, making it uncompetitive in the commercial market. If entrepreneurs are not careful, their high growth startup could end up evolving into the dreaded industry colloquialism, “an SBIR Shop” living from contract to contract with little hope of making it big. Such government dependence can be traumatizing to companies, as proven by the still hemorrhaging United Space Alliance, and the series of sellings, downsizings, and mergers between companies like United Technologies and Rockwell International, all as a result of the retiring of the Shuttle program.

Large public companies like Boeing and Lockheed Martin are also susceptible to bloated cost structures resulting from doing too much government work, and this phenomenon created an opportunity that Elon Musk exploited with SpaceX. SET created its own vertically integrated cost structure, free from the influence of decades of government cost-plus contracts, resulting in a more cost-competitive product. SET then went on to win several government contracts, but with its fundamentally lower costs structure, it also attracted commercial customers for a more balanced mix of buyers.

Winning a non-dilutive government contract that provides cash, validation, and a reference customer will delight investors in the short term, but it is a mixed blessing. The paradox entrepreneurs face with government contracts can be resolved with careful planning. Keeping the business on its high-growth path must remain a top priority. Ultimately, a company’s structure and culture must remain at its core, capable of rapid innovation required for lasting success in commercial markets.

This article appeared in the April 2013 edition of NewSpace Global’s Thruster market analysis report.

Space investing: For a fledgling NewSpace startup bootstrapping its way to success, a government contract can provide much needed cash flow and early market validation for a company’s technology. Entrepreneurs leading companies tracked on NewSpace Global’s NSG 100 Index, from Jeff Greason of XCOR to Jonathan Goff of Altius Space Machines to John Carmack of Armadillo Aerospace, are wooed semi-annually by an alphabet soup of public sector monies. In other words, they are lured by SBIRs (Small Business Innovative Research), STTRs (Small Business Technology Transfer) and NIACs (NASA Innovative Advanced Concepts) from the likes of NASA, DARPA (Defense Advanced Research Projects Agency) and the DoD (The Department of Defense). However, for early-stage investors, is there a “dark side” to working for the government so early in a company’s life?

The benefits of landing a government contract are numerous. Government research and development contracts can be a boost to the balance sheet without busting the cap table. “It’s non-dilutive capital that usually pays for the things you’d use investor capital to develop anyways,” according to Jon Goff, CEO of ASM and co-founder of Masten Space Systems. Goff’s company worked early on with DARPA to demonstrate its “Sticky-Boom” technology. Active NewSpace investor and Space Angels Network Founding Member Ed Tuck also sees government contracts as a way to answer one of the key questions about a new company: “Is someone going to buy their product?” Government agencies can tolerate more risk than many commercial customers, resulting in the government often leading the way as a first customer for new cutting-edge technologies.

Having the government as a customer is one thing, but having the government as your only customer – i.e. a monopsony – is another. Dan Mindus, also a member of Space Angels Network, points out that “no business wants to be dependent on a single customer,” and he sees the government as “particularly challenging.” Government agencies tend to have long sales cycles and, perhaps most importantly, government deals often don’t scale commensurate with the returns expected by investors with capital at risk.

Investors and successful entrepreneurs alike give one piece of advice consistently regarding government contracts: don’t get addicted. Ed Tuck has seen companies get bogged down by government contracts. “[A government contract] consumes a small company’s attention, because it takes resources, and the company usually has to add accounting and staff to take care of the unusual way the government does its accounting.” Jon Goff admits that once you have cracked the code for how to write a good government proposal, it’s hard not to get hooked.

Both of these observations are consistent with a management theory penned by strategy guru Clayton Christensen, known as the Resources, Processes and Values framework that warns about matching a company’s capabilities to its goals. According to Christensen’s simple but elegant theory, a company only gets good at the things that it actually does. A company whose only customer is the government gets really good at serving that customer and perpetuating the situation, often to the disappointment of early-stage investors hoping to see rapid growth, innovation, and high returns.

Depending on their structure, government contracts can have limited upside. A “Cost-Plus” contract, one such contracting mechanism, reimburses companies for their costs and provides a fixed profit margin. Operating under this type of regime exclusively for too long can permanently alter a company’s cost structure, making it uncompetitive in the commercial market. If entrepreneurs are not careful, their high growth startup could end up evolving into the dreaded industry colloquialism, “an SBIR Shop” living from contract to contract with little hope of making it big. Such government dependence can be traumatizing to companies, as proven by the still hemorrhaging United Space Alliance, and the series of sellings, downsizings, and mergers between companies like United Technologies and Rockwell International, all as a result of the retiring of the Shuttle program.

Large public companies like Boeing and Lockheed Martin are also susceptible to bloated cost structures resulting from doing too much government work, and this phenomenon created an opportunity that Elon Musk exploited with SpaceX. SET created its own vertically integrated cost structure, free from the influence of decades of government cost-plus contracts, resulting in a more cost-competitive product. SET then went on to win several government contracts, but with its fundamentally lower costs structure, it also attracted commercial customers for a more balanced mix of buyers.

Winning a non-dilutive government contract that provides cash, validation, and a reference customer will delight investors in the short term, but it is a mixed blessing. The paradox entrepreneurs face with government contracts can be resolved with careful planning. Keeping the business on its high-growth path must remain a top priority. Ultimately, a company’s structure and culture must remain at its core, capable of rapid innovation required for lasting success in commercial markets.

This article appeared in the April 2013 edition of NewSpace Global’s Thruster market analysis report.

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