DoD Can Motivate Tech Industry to Work On Defense Programs

By Teka Thomas
For a quarter century after World War II, the technology industry in the Bay Area was fueled primarily by the Defense Department. Today, the tech industry doesn’t need the Pentagon’s dollars as much as the Pentagon needs cutting-edge innovation. 

To bridge the gap, the defense community must understand the motivations and fears of West Coast technologists.

The yeoman software entrepreneur, for instance, is looking to build a product and receive funding with the least amount of accountability. Selling in the marketplace is of course the best form of financing. Market feedback is also the best source of guidance for ongoing product design. Besides warranties and normal consumer laws, there is little accountability to the market writ large. This is not the case in selling to Uncle Sam.

Building a product usually requires early financing. Initial seed money may only require giving up a slice of equity, but further funding rounds with venture capitalists usually requires giving up board seats, giving up pay-out preferences in case of liquidation, and structurally giving away more equity. A lot of control, including potentially the founder’s job, is sacrificed for early money.

Intellectual property is a major issue. Suffice it to say, the government wants to control or license IP it has a hand in paying to develop, as well get possession of the technical data. Technical data can be thought of as the map to a treasure chest, and the copyrighted or patented technology as the treasure. The government wants to quickly be able to re-engineer technology the government has already paid for. Needless to say, being accountable for such restrictions hurts the profitability of the company that developed the technology.

There are investors who provide critical early money, but take away a lot of mindshare by altering the corporate politics and governance of the company. With the government, use of technology comes with strings attached that are a major liability for a company.

The ethos in Silicon Valley is that the goal for most people is an “exit.” This is especially true for professional investors. An exit is usually an acquisition of the company, a major sale of the stock to another, or in rare cases an initial public offering of stock. If an exit is the long-term goal, capitalization (the speculated worth of the company) is the constant obsession. This is different from raw sales. Many websites and apps have been acquired long before any sales because of the potential in the technology. The technology ecosystem in Northern Virginia lives more by selling contracts. As of early March, the three largest defense contractors by revenue — Lockheed Martin, Boeing and Northrop Grumman — had a combined market cap of $202 billion. Facebook’s was $225 billion.

For Pentagon program managers and contracting officers looking at Northern California’s ecosystem, understand that the technology, and the right to control the use of that technology is the coin of the realm. It is the speculation of how technology can sell and be applied to other uses that drive the stock of the company that owns it. A short-term sale to the government, which diffuses the technical data, is usually not worth the potential change in market capitalization.

Some typical scenarios for when the government would want to engage a software company include a work-for-hire contract to conduct research and development, licensing or modifying previously developed technology, or perhaps installing some type of business process software.

In work for hire bids, often subcontractors with protected technology risk having to share it with the prime contractor. Even if legal contracts were put in place, with employee transfers and human nature, often the fruit of creative, innovative and expensive labor can be shared without compensation. 

“Modifications” for government purposes are inherently fraught with misunderstanding. The government is used to having bargaining power, but with the scale of private financing out West, companies with truly innovative products, and the capacity to keep innovating, have a strong hand. 

These are all major business risks. The entrepreneur has to deal with employees who have stock options, a board of directors and other investors or shareholders. The employees could revolt, the board could fire them and investors could sue if decisions are made that lower the trajectory of the stock price.

Risks of the government giving away technology when it gets “unlimited rights” are obvious. Less obvious are the risks of government purpose rights being handled day-to-day by embedded contractors. Those internal contractors could, even without malicious intent, share secrets of the outside vendor within the contractor’s own company. As the government becomes more privatized, industry will no longer see it as a public trust. 

Here are some typical situations that government officers, large experienced defense firms as well as new firms can be expected to face.

In the first case, a tiny tech company develops a narrow, focused technology.

A savvy military program manager reading periodicals for angel investment, notices a small firm operating out of an incubator in Palo Alto, California. The firm is developing a platform that could significantly aid in monitoring the health of troops in the field in real time. In concert with a crafty contracting officer, they move to get this technology operational.

Subject inventions are made to order from government requirements. If either the idea is conceived, or the actual reduction to practice occurs while under contract, the government has a strong license to use and even give away the technology.  The vendor has title and can use it, but not exclusively.

In review, Technical Data (DFARS 252.227-7013) the processed output from these machines, as well as software copyrights (DFARS 227.7203-5(d)) would apply here. The government would want access to the software it is partly paying for as well as the data produced so the taxpayers don’t have to reinvent the wheel. The tech firm’s counsel would cite authority in the DFARS for specifically negotiated license rights. The key is tracing who paid for what development, and “marking” the company’s original work. Lastly, label that version of the software as being shared with the government.

To maintain information as a trade secret, it must be just that, secret. The business strategy and IP rights with the government — and thus the government’s other contractors — need to be taken into account when deciding to apply for a patent.

In case two, an existing technology is altered with a military twist.

A contracting officer notices a social networking tool that specializes in communicating in rare languages and symbols. Thinking a component of it would be great for long-term unconventional warfare, she and the program manager seek a part of the platform to use, but with military grade security.

How much change is “change” is the biggest issue in federal procurement IP law. Laying out the technical configuration of the software or hardware is the first step of the company’s negotiation.  Then working with the government’s technical team to decide what is being “modified” and how much the function is changing is key. The negotiation process may leak some company secrets, but non-disclosure agreements ought to be signed and certain things can be generalized.

In the third case, a subcontractor with valuable IP finds itself in a work-for-hire situation.

A West Coast company with no federal procurement experience has developed a scope for zoologists to spot the exact geographic coordinates of specific animals using heat imaging. Wanting drones, helicopters and planes to be able track the exact location of people, a large defense company in Tysons Corner, Virginia, approaches the company to be a subcontractor and get federal experience.

The Virginia company stands to gain title to the new military technology.  The tech company stands to make some money off the deal, but would potentially lose any exclusivity in either a patent and/or the institutional knowledge in marketing the technology. 

This is a perilous situation for subcontractors, but by using the law, and administrative safeguards, their interests can be protected. DFARS 227.7103-15 defines the rights of a subcontractor and 227.7103-6 articulates the clauses that would be applicable. There are situations where the subcontractor can have “privity” (can deal directly with) the government in sharing trade secrets and IP. Furthermore, it is policy to prevent prime contractors from using leverage to get at that material.

The general solutions to these issues certainly lie in the government becoming closer to the tech community. Meetings with promising companies should happen before their Series A round when venture capitalists come into the corporate governance picture. Other opportunities are distressed companies that have a valuable product that is not marketable.

In this case, a government contract to sustain the key employees is better than investors folding the company. 

The most equitable solutions will come from really understanding what is valuable to the entrepreneur and forging contracts that are in everyone’s long-term interest. With companies looking to grow in equity, program managers and contracting officers must think differently in inducing businesses that are not primarily focused on revenue with strings attached.

Teka Thomas is a business attorney in Washington, D.C.

Topics: Business Trends, Doing Business with the Government, Defense Department, Infotech

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