Shane Wilson's Blog

“Dragon Drones” popped across my newsfeed last fall.  Unlike most clickbait, this article’s subject was as interesting (and terrifying) as it sounds.  Fighters on the frontline of the Russia-Ukraine war have modified drones to carry payloads of thermite- a combustible metal powder fuel that burns in excess of 4500°F.   Thermite is a rather easy-to-acquire product with mundane applications like welding.  The intense heat profile of thermite makes it a prime candidate for burning organic cover hiding combatant installations and vehicles as it creates brush fires that can not be easily extinguished.  Enter dragon drones: hell-fire rained down from simple remote control drones that are attempting to break the tactical stalemate of the 21st Century’s first trench war.

Dragon drones, and drone warfare more broadly, represent a shift in the way the world builds and funds its war machine.  The integration of civilian products like FPV drones with available tools like thermite is a textbook demonstration of innovative creativity, a demonstration of 1+1=3.  For decades, defense spending has been concentrated in large companies like RTX, Lockheed Martin, and Northrop Grumman.  These companies have grown rich from working closely with the DoD to develop vehicles, planes, and ordnance that match the specs of military organizations.  This leads to lucrative, long-term, cost-plus margin contracts that create little incentive for defense companies to produce their wares more efficiently- if Lockheed is over-budget on the delivery of an F-35 it’s of small concern as the DoD covers the entire cost of the project plus an additional margin to make the project profitable Lockheed.  [1] It doesn’t take an MBA to intuit what happens next- the cost of goods to the DoD, and ultimately the US taxpayer, balloons.  Until the Ukraine war, this was simply the cost of doing war business.  DoD is an exacting customer who needs partners that can create incredibly reliable products for niche capabilities at an enormous scale.  There are few companies who can fit this bill, and for those that can, they deserve to be rewarded- especially when we consider the fact that it is in the best interest of all US citizens that defense companies do not sell their wares on an open international market.  Yet when Ukraine’s troops are using an $800 drone equipped with an explosive device to eliminate enemy tanks with high precision, a task typically executed by a $200,000 Javelin missile produced by Northrup and RTX, it’s time to reevaluate business as usual.

Mega Startups Disrupting the Government and Defense Status Quo

Today, business-as-usual in the military industrial complex is being reevaluated.  Ukrainian drones are definitely inspiration for lower-cost defense products, but it’s unlikely an army of inventors and tinkerers will ever be able to fully replace the military contractors of the United States military… but Space-X and Anduril may.  Efforts to innovate defense spending, and more broadly government agency spending, pre-date the Ukraine war as evidenced by the cosmic rise of Space-X.  It is estimated that Space-X has won nearly $20B in government contracts. [2]  The amount of funds Space-X has earned from government entities is not the key detail, it is the amount of funds awarded to a relatively unproven entity that demonstrates the shift.  Many are familiar with the make-or-break Falcon 1 launch of 2008 which has been tagged as the key inflection point for Space-X and much of the subsequent success of Musk Co. [3] Following just this one launch of Falcon 1, Space-X enjoyed a glut of government contracts that sustained the future of the company.  Falcon 1 was an incredible accomplishment, but it was still one success that followed a series of disastrous failures.  The ‘one is good enough for us’ diligence regarding Space-X is a strong demonstration of a new-found ‘risk on’ strategy for government agencies. 

Anduril is another example of a start-up threatening business-as-usual in the military industrial complex.  Founded in 2017, Anduril brought Silicon Valley’s “move fast and break things” mindset to the defense sector.  It has since raised over $4B and achieved a $14B valuation. [4] A quick browse of Anduril’s site feels a bit like Sci-Fi movie (a distinctly scary Sci-Fi movie, at that) with video demos of various AI-powered devices that monitor airspace, traverse the air or seas autonomously, and suddenly explode to eliminate targets.  Anduril’s products are innovative in their own right, but to me the most exciting innovations are in the company’s strategy.  As a company launched in the post-digital era, Anduril’s tech-native DNA inspired its approach to develop Lattice OS as its first product, an “integrated, persistent awareness and security [Operating System for uses] across land, sea, and air” which powers all of its hardware devices.  [5] Building Anduril on Lattice OS is an advantage available to a new company not saddled with decades of technology debt. Yet this decision required some retrofitting to gain acceptance.  From Trae Stephens, Anduril’s executive chairman:

“We found that selling software was incredibly difficult. There’s almost a moral aversion to paying software margins inside of the DoD. Our focus was putting the thing we know DoD really needed, which was the software system/autonomy capability, and wrapping it in metal because it is significantly easier for the customer to buy metal than it is to buy the software. We use that as a Trojan horse to get software in the front door.” [6]

Anduril’s platform positioning has led the company to research and develop its products in-house: a big change from traditional defense companies who look to specifications provided by government agencies for inspiration.  This approach means Anduril can ‘surprise and delight’ government entities with capabilities they had previously not thought of.  It also means Anduril can set prices for its complete products in a way not possible in cost-plus-margin contracts.

Anduril and Space-X are paragons of 21st century innovation, but they’re also demonstrations of ‘what is old is new again’ as they represent the re-convergence of the innovation and defense economies.  Investment in innovation has closely followed government investment since World War II- a topic I’ve enjoyed learning from William H. Janeway, a founding father of the modern Venture Capital sector.  Janeway visited us at Yale in the Fall of 2024 where he introduced us to the concept of ‘dance floors’ that has inspired my research into Defense and Dual Use technologies.  I’ve since read his book, Doing Capitalism in the Innovation Economy which provides a first-person perspective of the rise of Venture Capital in the second half of the 20th century from Janeway’s perspective as an economist studying the phenomena of financial bubbles at Cambridge and Princeton in the 1960s, to an investment banker innovating new methods for funding companies in the 1970s and early 80s, to one of the first true Venture Capitalists at Warburg Pincus where Janeway helped fund some of the massive winners of the first boom of the internet economy.  Janeway contends that virtually all successful VC investments are beneficiaries of significant government spending.  Janeway’s simplification of the Innovation Economy cycle begins:

1. Government invests in basic research and infrastructure.
2. This creates “dance floors” or platforms for innovation.
3. Entrepreneurs and VCs build and invest (or dance?) on these platforms.
4. Financial speculation further fuels investment in promising ventures.
5. Some ventures succeed spectacularly, while many fail. [7]

The internet and the corresponding digital revolution is a perfect example.  Years of DoD investment in communication technology, computers, and digital systems made the internet possible.  The internet then became a massive dance floor on which countless new products from private companies were developed (and fortunes have been made). 

The Defense Innovation Unit (DIU)

Today’s entrepreneurs and early-stage VC investors can use Janeway’s model and the success of Anduril and Space-X to inspire new endeavours- I propose the Defense Innovation Unit (DIU) is a great place to look for inspiration.  The DIU is a Department of Defense (DoD) organization focused on rapidly adopting and scaling commercial technologies to address critical national security challenges.  DIU’s mission is 3-part: to accelerate DoD adoption of commercial technology, transform military capacity and capabilities, and strengthen the national security base.  With a heavy presence in Silicon Valley, DIU bridges the gap between innovative tech companies and the U.S. military, accelerating the deployment of cutting-edge solutions. [8]  Channeling Janeway, DIU is a dancefloor maker.  Currently, DIU has 6 focus areas in which it looks for new products and companies: 

• Artificial Intelligence
• Autonomy
• Cyber and Telecom
• Emerging Technology
• Energy
• Human Systems
• Space

DIU collaborates with DoD partners to create Commercial Solutions Openings (CSOs) that solicit solutions to defense challenges.  Solutions deemed worthy of the CSO are awarded Prototype Other Transaction (OT) Agreements which quickly infuse capital in fledgling projects and create a pathway for early-stage companies to provide full-scale defense solutions.  DIU represents innovation in government procurement- its flexible agreements are often executed within 60-90 days meaning that a Seed or Series-A startup could earn business from the world’s biggest client in roughly 1 fiscal quarter.

Lacking a military background, DIU first came to my attention when interviewing for a fellowship with a dual use/defense tech VC last Fall.  After spending a summer in climate tech, I was disappointed to learn that many climate-focused VCs will not invest in any type of hardware or deeptech regardless of their potential impact as these asset-heavy sectors have challenging return profiles.  DIU’s presence in the startup ecosystem could rebalance the equation for early-stage VCs interested in hard tech.  Outside of climate, I’d be surprised to find any VC who wouldn’t be interested in their portcos landing the world’s biggest customer.  If a $5mm Series A will resource a startup enough to win a CSO, DIU’s support for the prototyping phase and subsequent order flow could help survive the valley of death.

DIU and valuation lift-off: Joby Aviation

Joby Aviation is a great example of how DIU collaboration can make a startup with high technology and market risk viable.  The company is developing all-electric vertical takeoff and landing (eVTOL) aircraft for ridesharing.  Joby went public in 2021 and boasts a current Market Cap of about $6.25B.  

Joby Aviation Timeline [9]

2009: Joby Aviation Founded

2011: Raised $11mm Seed Round at a $35mm valuation

2016: Joby awarded DIU contract worth $20mm

2016: Joby raises $15.5mm Series A round at a $59mm valuation

2017: Joby raises $100mm Series B round at a $450mm valuation

2020: Joby raises $590 Series C round at a $2.6B valuation

2021: Joby IPOs, $6.4B EV

2022: Joby indicates DIU relationship has led to contracts with US Air Force

2024: Joby announces $131mm contract with USAF to develop 2 eVTOL prototypes

As of Q3 2024, Joby’s aircraft are not commercially available- prototypes are making appearances at air shows and are in early stages of testing with regulatory agencies.  While there are some revenues reported for “Flight Services,” the company lost $370mm in the first 9 months of 2024. [10]

Without proprietary information and a quick look at the above timeline, it’s clear to me that Joby’s valuation would not have taken off without the DIU’s involvement beginning in 2016.  Between the 2016 Series A and the 2017 Series B, Joby’s valuation increased by 7.6x.  This is likely the window of time when Joby graduated from DIU prototype awards to early DIU orders. More recently, Joby’s announcement of a $131mm contract with USAF in 2024 was quickly followed by a $500mm investment commitment from Toyota.   Joby is a great case study in how public funding reduces market and technology risk to make asset-intensive, sci-fi type technology investable.

A Brief DIU Startups Watchlist

Here is a sample of companies in high-tech and high-market risk sectors who have disclosed their work with the DIU that have significant runway for continued growth.  

DIU Mandate	Total Funding	Latest Valuation	Private Investors
Energy	$811.47 mm	$1.40 B	Breakthrough EnergyGreentown LabsPrelude VenturesBill Gates, Richard Branson, Jeff Bezos

With a $1B valuation, Fervo is not exactly an under-the-radar startup, but its headstart in the promising geothermal energy production space means there’s potential for significantly more valuation growth.  Founded in 2017, Fervo leverages technologies from the oil and gas industry such as horizontal drilling and distributed fiber optic sensing to unlock intense heat from the earth.  Water is pumped down to the bottoms of these wells which returns to the surface as steam- this steam spins power turbines and creates electricity.  Geothermal is so exciting because it is a theoretically inexhaustible energy source that creates non-intermittent renewable energy.

Fervo has proven its technology and that geothermal energy is technically feasible, though not yet commercially viable compared to sources like wind and solar.  Fervo is betting that continued success at early installations will jumpstart demand for geothermal energy which will bring geothermal’s LCOE into the commercially viable range in the next 5-10 years.

DIU facilitated a contract with Fervo to power NAS Fallon, a Naval air station in Nevada in April 2024.

DIU Mandate	Total Funding	Latest Valuation	Private Investors
Autonomy	Undisclosed	Undisclosed	CoatueKhosla

Swarm Aero specializes in developing technologies to coordinate large swarms of drones for military attacks.  Swarm Aero’s data on PitchBook is pretty light, yet this 37-person company has been selected alongside Anduril (3,700 employees) and L3 Technologies (17,000 employees) to support DIU’s Replicator initiative. [11] Replicator is a DIU-led initiative to expand DoD’s autonomous capabilities which received $500mm in funding in 2024. [12]  Though I cannot find details on the amount Swarm Aero was awarded through the Replicator contract, Coatue and Khosla’s presence on the cap table is a good indicator of this company’s long term value prospects.  I suspect we’ll see an announcement of a big raise from Swarm Aero in H1 2025.

DIU Mandate	Total Funding	Latest Valuation	Private Investors
AI	$91mm	$575mm	General CatalystShield CapitalAloft VCPoint72 Ventures

Vannevar Labs, founded in 2019, creates intelligence warfare products that leverage artificial intelligence (AI) and machine learning (ML) to enhance intelligence gathering and analysis capabilities. Their software and hardware solutions enable customers to maintain maritime vigilance, disrupt misinformation, and collect non-traditional intelligence. [13]

In November 2024, Vannevar graduated from its DIU prototype contract to a production contract with a ceiling value of $99mm ($16mm guaranteed).  If successful, Vannevar will eclipse its total funding with just this one contract within 5 years of founding- this is a dream for an early stage investor!

Wrapping Up

Geopolitical tension is increasing at a scale that hasn’t been seen in a generation.  Russia’s invasion in Ukraine is entering year 4.  While a ceasefire has begun between Israel and Palestine, destabilizing events in the region including the fall of Syria could signal deeper conflict in the Middle East in coming years.  The simmering conflict between the United States and China is likely to eclipse all of these.  These factors point to a world that will be spending more on defense and this spending will not just go to traditional defense companies- many startups that effectively position their products for defense and dual-use purposes will benefit from next-gen procurement practices that can lead to rapid valuation increases.  This market dynamic is one founders and investors should all be focusing on.  The history of successful investment in innovation is closely tied to government spending.  The breadth of spending sectors which includes areas like energy and cybersecurity means that companies that are not explicitly designed to support war efforts can benefit from this lucrative opportunity.

Citations

[1] HigherGov- Sample Contract for F-35 

[2] CNN- How much of Musk’s wealth comes from tax dollars and government help?

[3] ABC News- SpaceX calls off nail-biting catch attempt as booster splashes down to Earth

[4] Pitchbook- Anduril Profile

[5] Contrary Research- Anduril

[6] Ibid.

[7]  Doing Capitalism in the Innovation Economy, summarization provided by Perplexity AI

[8] DIU- About Us page

[9] Fundraise and Valuation data from Pitchbook.  Defense spending from announcements on Joby website 2016, 2022, 2024.

[10]  Joby Shareholder Letter, Q3 2024.  

[11] Employee headcount numbers from LinkedIn.  DIU announcement for winners of Replicator initiative business accessible here.

[12] Ibid.

[13] Vannevar Labs- Vannevar Labs Awarded Defense Innovation Unit Production Contract, Enabling Deployment at Scale Across the Department of Defense