Pentagon teams up with SBA to sweeten the pot for tech investments

WASHINGTON — The Pentagon controls spy satellites, special operators and nuclear weapons, but there’s one thing it can’t do that 118 other government offices can: run a federal credit program, using loans and loan guarantees to boost private-sector investment in its priorities.

That’s the legal limitation the Defense Department faces as it stands up a brand-new Office of Strategic Capital to encourage investment in cutting-edge technology, OSC director Jason Rathje explained Friday at the Center for Strategic & International Studies.

So, at least for now, OSC must work through partners outside the Pentagon to entice investment in tech the DoD wants to see developed — especially when it comes to the critical hardware like semiconductors and nanotubes, which have suffered neglect as investment sought higher returns in software.

Its first effort will piggyback on the Small Business Administration’s Small Business Investment Company (SBIC) program. SBA, unlike the Defense Department, can legally leverage “the full faith and credit” of the federal government to guarantee loans to innovative firms. The aim is to give private investors more confidence to invest their own money in technologies that might otherwise be too high-risk or low-return.

“Through this program, we provide loan guarantees to investors to raise debt to match with private capital,” Rathje said at CSIS. “I signed a MOA [Memorandum of Agreement] last Friday to officially ink the deal between the DoD and the SBA.”

“The SBIC program is one where we are absolutely reliant and dependent on the SBA,” he emphasized. “It is their program, it is their authority.”

The venture with SBIC is “the only program we’ve launched to date, [and] we have not started taking applications yet” from interested companies, he cautioned. That’s because OSC itself is still very much in a start-up phase, although Rathje and his staff have done about a year of prep work prior to December’s official launch.

In the 2024 budget, the Department of Defense has requested $115 million for OSC. But, Rathje emphasized, “the DoD does not have the authority today to do federal credit programs — there’s no Title X authority that allows us to do this.”

Rathje declined to state outright whether the Pentagon would request new authorities from Congress, saying only that “that is an ongoing conversation. We believe that we can build an effective organization through our interagency partnerships and increase our participation in the market, if granted the authority and appropriations to do so.”

“Internal to the Department, we are doing everything we can that [is] within the bounds of our existing authorities,” he said. “We are building our investment strategy, we are building our governance fora, we are building the structural piping inside of DoD to make this real…. What we are doing outside of that [is] interagency partnerships.”

There are plenty of potential partners out there. “Today, there are 118 federal credit programs,” Rathje said, for everything from high tech to veterans’ housing. “We have an entire system… to have government agencies issue debt, to do loans, loan guarantees… in nearly every single government department, except for the Department of Defense, Department of Justice, and the Department of Labor.” OSC, he said, wants to create “partnerships across the interagency to learn from these other programs.”

Operating through the authorities SBA and other agencies already have “allows us to start working now,” Rathje said. What he didn’t say out loud: It might be years — if ever — before Congress grants the Defense Department authority to do similar loan guarantees on its own. While legislators have pushed the Pentagon to work with innovative, non-traditional companies for years, there is still unease about anything that smacks of heavy-handed government intervention in the private sector.

That said, this form of industrial policy does have a long history in the US. The SBIC program, Rathje noted, was created in 1958, as part of the Eisenhower Administration’s response to the original “Sputnik moment” in 1957 when the US looked up at a Soviet satellite — the first artificial body to orbit the Earth — and realized it needed to step up its high-tech game. Today, six and a half decades later, the US is having similar spasms of anxiety about the People’s Republic of China, with its soaring investments in everything from artificial intelligence to hypersonics.

“There are a number of strategies … that the PRC uses to invest into private capital markets, to leverage private capital markets to support… critical technology areas,” Rathje explained. Over the last 10 years (2013-2022), one prominent type of Chinese instrument, so-called “guidance funds” that mix government and private-sector capital, have invested more than $900 billion, according to Financial Times.

US industrial policy is not nearly as heavy-handed, for both fiscal and philosophical reasons. “The United States takes, across the interagency, a very different strategy… where we invite and empower investors,” Rathje said. “We think about this, not in terms of subsidy, but as partnership, as co-investment. … It’s a choice.”

The goal of government loans and loan guarantees is to make certain investments attractive to private investors, he explained. That’s particularly important in fundamental components of hardware, such as advanced materials for semiconductor chips, because so many investors now favor software, which has lower risk and higher returns. In recent decades, Rathje said, venture capital investment went from a rough balance between software and hardware — 55 percent to 45 percent in 2006, for instance — to a massive imbalance: 92 percent to eight percent in 2017.

“The market for advanced materials companies is not nearly as large as the market for your enterprise SaaS [Software as a Service] companies, so capital doesn’t flow to those types of companies, to those types of technology areas,” he said.

“It’s a strong signal to us,” he said, that the Defense Department needs to encourage investment in new ways.