In-Q-Tel: The CIA’s Silicon Valley Bridge
on 09 August 2005, 22:00
by
staff Shortly after September 11, 2001, U.S. Secretary of Defense Donald Rumsfeld summoned a group of venture capitalists, techies, and high-finance types to the Pentagon. He wanted to talk about ways to deliver new technologies into the fight on terror. Fast.
The scheme hatched in that meeting was to start a pilot program designed to match venture capital and startups to specific problems the U.S. Department of Defense wasn’t solving. With VCs such as Wilber James from Rockport Partners, Ted Schlein from Kleiner Perkins, and John Kasich, a former U.S. Congressman and a partner at Lehman Brothers, in Mr. Rumsfeld’s office that day, it is likely that the participants already had a model in mind that would solve the problem. But knowing Mr. Rumsfeld’s hostility toward a certain government agency, it may be no surprise that it didn’t come up.
Lehman BrothersTwo years earlier, the Central Intelligence Agency had opened a venture capital arm in Silicon Valley. When the VC spooks first moved to Sand Hill Road, In-Q-Tel was regarded with no small measure of amusement and bemusement by its new neighbors. The firm got off to a slow start, but by the time al Qaeda destroyed the WorldTradeCenter, In-Q-Tel, named for James Bond’s gadget expert Q, had started to see some serious deals.
In-Q-Tel and the new Pentagon venture startup are not the only attempts to crank up the lugubrious pace of federal procurement with a snort of Silicon Valley speed: Both NASA and the U.S. Army have programs closely modeled on In-Q-Tel.
Even as the Pentagon keeps its plans quiet for now, it’s worth looking at In-Q-Tel six years after it started as an experiment in putting venture capital in the service of the feds.
Secret Success
To date, the CIA-backed venture firm can boast an impressive run. It has reviewed 5,000 business plans and invested $100 million in 80 companies and 10 projects in university research labs. Of those, only four have gone bust—impressive considering the 50 percent failure rate typical in the venture business. In 2004, In-Q-Tel invested in about two dozen companies. It has been involved in the development of 100 technologies central to its intelligence mission, and 12 of its portfolio companies have been named to Red Herring’s 100 Top Private Companies lists.
Red HerringDespite such successes, critics remain. They think the lack of oversight and compensation schemes for employees in In-Q-Tel are not adequately addressed.
Indeed, much about In-Q-Tel remains undercover. Calls to Senators’ offices involved in direct oversight of In-Q-Tel invariably provoke the response, “How do you spell that?” Congress’ research arm, the Government Accountability Office, has never issued a report on In-Q-Tel. The most recent study of In-Q-Tel came out in 2001.
Released one month before 9/11, the congressionally mandated Business Executives for National Security report on In-Q-Tel found that the CIA’s Silicon Valley experiment had experienced early success, and that “creating a model like In-Q-Tel makes good business sense.”
But no follow-up study has been made available to the public; the intelligence committees in both the U.S. House of Representatives and the Senate say that whatever reports they have on In-Q-Tel are classified.
Keeping Up
When the Berlin Wall came down in November 1989, it marked the end of the Cold War and spelled a new era for intelligence agencies. In the past, technologies were black-boxed, custom-designed and built for the intelligence agency. It was clear the old model was outdated, too expensive, and didn’t get the agency access to the latest and best technological innovations.
By the mid-1990s, the PC revolution was in full swing and the emergence of the World Wide Web spawned a flurry of technological innovations. It became obvious to the intelligence community that it couldn’t keep pace.
Technology ages fast, and delivering cutting-edge technology requires lots of money and talented engineers and scientists. The new generation of spy gadgets had moved past microphones hidden in a pack of gum to biological sensors to monitor toxic chemicals and language-processing software.
The pool of young talent from university campuses helping to fuel this revolution was attracted to Silicon Valley, with its thriving entrepreneurial community and rich rewards. It was a much larger talent pool than the CIA could possibly afford to assemble inside the walls of its headquarters in Langley, Virginia.
Why not take advantage of the market economics of technological innovation and ride that same curve to build the next generation of spy technologies, many of which would find broader use in the public markets? In-Q-Tel was born.
But early on in the creation of In-Q-Tel, doubters questioned the risk that goes hand-in-hand with the opportunity to gain access to innovative technology. How risky should the gambles made with taxpayer dollars be?
Because In-Q-Tel invests in much the same way a corporate venture firm does, it looks for those technologies that are central to solving problems its customer—the CIA—faces. While those needs change and evolve depending on the challenges faced by the CIA, In-Q-Tel is primarily interested in knowledge management technologies, information security tools, and security technologies that help authenticate access to data and services.
The most immediate need of the intelligence community is finding innovative technologies to address the gaps laid out in the 9/11 Commission Report. “All the good things that the government should have been doing that we didn’t have the capability to do,” says In-Q-Tel President and CEO Gilman Louie. “Any technologies to help people share that information, and leverage information that they’ve already collected and can be useful,” he says.
In-Q-Tel is also giving back to Silicon Valley. One of the key strengths that In-Q-Tel has brought to the venture industry is its deep expertise in technology. Three-quarters of its 66-member firm provides that deep knowledge from its Arlington, Virginia, location.In its first few years, the government-backed firm was a curiosity to venture capitalists in Silicon Valley. Its initial approach of leading investments was refined to one that followed alongside bigger, more experienced venture firms with bigger wallets, and hence larger stakes in the game.
Many of the companies that have received In-Q-Tel investments (which range from $250,000 to $3 million) laud its focused approach and high degree of expertise in science and technology. “You don’t approach them, they approach you—which is the opposite model of Silicon Valley,” says Robert Shaw, president and CEO of ArcSight, an In-Q-Tel investment that provides data collection and analysis for security products and corporate networks. “They’d done a year’s worth of due diligence and research before they approached us.”
One of the biggest doors that In-Q-Tel opens for its venture-backed companies is introductions and reference to other government agencies with budgets and needs for technology. “They introduced us and spread our name around the government. I’d say In-Q-Tel is as good or better than any other VC I’ve worked with,” says Mr. Shaw.
There is other evidence of In-Q-Tel’s ability to pick strong startups that are not only solid fits for intelligence agencies, but also innovators in business and consumer markets. In January, IBM acquired Systems Research & Development (SRD), which provides software applications to combat fraud and theft. Last fall, Google acquired Keyhole, which had developed clever map visualization software. That move triggered acquisitions by Yahoo and MSN to bolster map search technology. And in 2003, Symantec purchased network security firm SafeWeb.
IBMYahooThese successes have led to copycat venture firms like the Army’s OnPoint Technologies. Started in 2002, OnPoint has invested in eight companies ranging from thin solar technology to next-generation rechargeable batteries and fuel cells. Its overall investment objectives are to develop power or energy sources capable of operating in long missions without re-charging. Portable power is a big pain point for equipping U.S. Army soldiers, who typically lug around 40 pounds of spare batteries in their packs. In June, OnPoint invested in Nanosolar, which has developed a thin film solar technology for printing of solar cells on flexible polymer-based substrates.
OnPoint’s fund is less than $50 million. “We like to invest alongside other venture investors, butmore importantly, we focus on strategic investment opportunities for the Army,” says Jason Rottenberg, managing director of OnPoint Technologies. “We are much smaller than In-Q-Tel and we’re trying to leverage from what they’ve learned.”
“We like to invest alongside other venture investors, butmore importantly, we focus on strategic investment opportunities for the Army,” says Jason Rottenberg, managing director of OnPoint Technologies.
NASA is also planning an In-Q-Tel-like foray into cultivating technology with venture capital, but declined to comment on its plans.
And of course, there is the result of Mr. Rumsfeld’s meeting. Mr. Kasich, co-founder of the Pentagon’s venture capital pilot program and now a managing partner at Lehman Brothers, says the Pentagon pilot program did not have the same slow start. The experiment—called Defense Venture Catalyst Initiative, or DaVinci—is in the process of becoming a more formalized Pentagon institution.
Venture CatalystThis is because it has been a smashing success, says Mr. James, a managing general partner at Rockport Capital, which specializes in cleantech energy investments. A couple of years after DaVinci started, Mr. Rumsfeld called some of the original attendees from that first meeting back to the Pentagon. According to Mr. James, the Secretary of Defense held up a full binder and said, “This is what you guys have done, but I can’t tell you what it is.”
The Pentagon is still tight-lipped about what plans it has for DaVinci. Steven King, special advisor for critical infrastructure protection at the Pentagon, and one of the lead people working on DaVinci, declined to be interviewed for this article. Mr. James and Mr. Kasich both say DaVinci will not be a Pentagon version of In-Q-Tel.
But Mr. James says he does fear that as DaVinci evolves and becomes an institution inside the Pentagon, it will lose some of its effectiveness. Government bureaucracy could slow it down.
No G.I. Pay Rates
Comparisons with the traditional practice of government have led to some criticism of In-Q-Tel. An investigative story that appeared in the New York Post in May raised questions about compensation for In-Q-Tel employees.
Two years after In-Q-Tel opened its doors, it designed a compensation scheme for its employees that departed from a typical salary model to give staffers incentive to work harder. The 66 employees of the venture firm receive a salary and equity positions in all of the companies In-Q-Tel has funded.
Roughly 9 to 40 percent of an employee’s salary is invested into the Employee Investment Fund, a mandatory long-term incentive component. The plan is unlike a typical 401K retirement fund in that each staffer cannot choose which of the companies in the In-Q-Tel portfolio to invest their money into. What’s more, employees don’t have any control over the timing and distribution of the equity proceeds from the fund.
The stakes are evenly spread across the spectrum of companies, says Mr. Louie. Each employee is issued what is defined as 144 restrictive stock, which 501c3 nonprofits abide by. The guidelines are designed to ensure that the nonprofit, In-Q-Tel in this case, doesn’t gamble and jeopardize taxpayers’ investments in technology startups. Essentially, for every $4 invested in a company, $1 is invested in the employee fund.
In-Q-Tel’s tax returns for 2001 and 2002 reveal that employee compensation is definitely out of line with a typical government agency. The base salary for the CEO is determined based on the Mercer, Watson Wyatt, and PricewaterhouseCoopers compensation survey for comparable positions in the High Technology, Nonprofit, Government Contractors and Venture Capital Firms.
According to In-Q-Tel’s 2002 tax returns obtained by Red Herring, Mr. Louie’s compensation in 2001 totaled $760,706 and his contributions to employee benefit plans and deferred compensation was $15,822. Of the nine officers listed in that 2002 return, the total compensation to CEO, nine officers and seven directors was $3,715,511.
Red Herring“Compensation depends on the staff member,” says Mr. Louie. “For myself, 30 percent of my compensation is salary, two-thirds is based on performance, and 20 percent is based on long-term equity positions.”He sad he donates the equity to charity.
The six-year
In-Q-Tel experiment, designed to give intelligence agencies access to the cutting-edge technologies, has forged a strong foundation in Silicon Valley’s entrepreneurial culture. As other similar government efforts move ahead, questions remain about adequate oversight and value delivered to taxpayers. All the while, other foreign governments are watching closely to see if this U.S. approach can be leveraged on their
