From the April 25

From the April 25, 2003 print edition

Venture capital starts flowing toward defense

Amy Bryer

Staggered by dot-com era losses, venture capital firms are looking for predictability in their next investments and are finding it in government contractors.

At the height of the high-tech boom, VCs invested $210 billion over the five years ending in 2000. When the party ended, however, the average loss in 2001 was nearly 28 percent and was 23 percent in 2002, according to Thomson Venture Economics for the National Venture Capital Association.

As venture capitalists lick their wounds, some experts say this is the time for government contractors emerging from the nation's new emphasis on homeland security to pounce.

"There's an argument that a lot of money is coming in that direction," Tom Howard, a University of Denver Daniels College of Business professor of finance.

Broomfield-based Vista Ventures, which traditionally invested in IT and communications companies -- like data storage company Boulder-based Lefthand Networks -- is now looking at companies that sell homeland-security products.

Government contractors have been traditionally overlooked by VC firms, said Martin O'Brien, vice president of Littleton-based Ophir Corp., a defense contractor for more than 20 years.

Ophir manufactures an atmospheric measuring device installed in all of the Stealth bombers.

"They would never touch us," O'Brien said.

It's not that VCs have an aversion to revenue that comes from the government, it's that government contractors grow too slowly for VCs, said Sanjai Bhagat, a University of Colorado professor of finance.

"VCs traditionally invested in high-risk companies for high returns," Bhagat said.

VCs look for rapid growth because they need to see a return on their money within five to seven years and that time frame has been too short for government contractors, said Craig Hanson, principal with $65 million Vista Ventures.

Under these terms, venture capital companies can lose money even under the best economic conditions, Bhagat said.

VCs are known for taking risks, but were even less careful than normal during the late 1990s -- and they got burned, Bhagat said.

The whole industry is moving away from early-stage funding and now they are all trying to climb the financial ladder, Howard said.

As a result, venture capitalists are looking for companies that have more stability -- and government contractors fit that bill.

President Bush has requested a Department of Defense budget of up to $380 billion for fiscal 2003, $40 billion more than last year. Another $60 billion-plus will be spent on defense electronics and IT and $20 billion for civilian agencies' IT.

The administration's plan for homeland defense includes a $3.5 billion budget for first responders, $11 billion for border security, $6 billion for defense against bioterrorism and $700 million for intelligence gathering and information sharing, according to the Venture Capital Journal, a publication by Thomson Financial.

With the country's emphasis on homeland security, many commercial companies are joining the fray and competing for that influx of funding through government contracts.

Vista Ventures is looking for companies that are taking advantage of the government's new direction, Hanson said. Vista finds businesses attractive if they have potential for rapid commercial growth with the product they have developed through a government contract.

One example is Lakewood-based Mar-shall Austin Productions, a company that started by providing portable staging equipment for concerts, but now sells staging equipment to the military.

The image of defense contractors has changed, said Jim Sampson, president of Fort Collins-based Scion Industries, a company that builds molds for planes and other spacecraft.

"You don't have to be a Lockheed [Martin] to invent the software or computer system anymore because you can buy an off-the-shelf chip and do it yourself," Sampson said.

Some of the small businesses have potential for a lot of growth, but the question remains how long will security be a big deal in this country, Howard said.

"I doubt we'll go back to where we were before [prior to Sept. 11], but I don't believe it will be much more than we are at now," he said. "I think we may come to our senses and say the attacks of 9/11 created security concerns, but maybe we went too far."

The security fears have created an impossible standard to maintain and the country will have to ask whether this is what it wants to spend money on, Howard said.

The growth for these government contractors is only as great as the amount of money the government wants to spend on homeland security.

"Every industry has its risks and that would be the risk of this one," Howard said.