We should view GovTech as a high-risk technology sector—and fund it as such.
Over coffee, a technology entrepreneur bemoans to me the lack of early-stage venture capital available to him. The principal client for his start-up is government and, as a recent Knight Foundation report describes, ‘Venture investors have a long-standing aversion toward companies with government sales models.’ A new UK Government policy paper describes Govtech, or government technology, as a ‘promising’ new industry, but when venture capitalists (VCs) see start-ups for whom government is client, they often perceive risk, slowness, and uncertain growth trajectories.
These cautious investors are not completely wrong. The risks for new Govtech companies stack up. They include myriad hurdles to adoption and development of digital innovations in the public sector, from lack of opportunities to run pilots to long and complex procurement processes. Entrepreneurs may also face difficulty in identifying purchasing decision-makers; slow buying decisions; public-sector resistance to working with start-ups and SMEs; and policy instability. In many countries, moreover, the shortest timeframe to submit a bid for open tendering is over 50 days—possibly a lifetime for a start-up.
Many Govtech ventures sit at the applied end of the innovation lifecycle. Procurement or constituent communications platforms, for example, operationalise existing technologies for public sector needs. They thus lack the profound uncertainties and extended timeframes of companies in industries addressing questions of basic technological feasibility. Those industries, such as nanotechnology, are typically considered to need ‘patient’ financing—investment accepting of uncertain conditions and long and inexact timeframes. Yet the demand-side risks faced by Govtech ventures means that they too require patient investors. The ambitions of the Govtech industry to serve government as client and the objectives of its funders, to cash in quickly on a market valued in the multi-billions, will otherwise conflict.
Govtech founders’ desires for VC funding are understandable. But many VCs seek returns on investments in just three to five years. Funding deployed with a demand for unrealistically speedy profit could harm the Govtech industry by curtailing the time available to entrepreneurs to grasp and navigate the most precarious aspects of their enterprise. Mismatched timeframes could yield a cohort of companies that fail to acquire the depth of experience to negotiate government procurement processes or build familiarity with institutional cultures and key decision makers in the departments into which they seek to sell. Even entrepreneurs with public-sector backgrounds are unlikely to have extensive knowledge of multiple departments across several governments. Lack of time to correct this inexperience could collapse individual Govtech enterprises or push them to pivot from the public sector towards quicker wins elsewhere. It may also limit knowledge diffusion across the industry, stunting its capacity to mature.
The early financial history of biotechnology—or ‘biotech’—is instructive. From the outset, biotech start-ups were flush with private venture capital funding. VCs were attracted to the industry for its promise to integrate basic and applied science, produce new drugs, and ultimately to generate outsized profits. But a rift quickly emerged between hasty investors and the pace of scientific research. VCs expected returns on their investments in under half a decade, a timeframe that outpaced drug development. The need for speed re-directed biotechnology entrepreneurs away from drug development, towards ‘lower-risk, faster-payback models’. The shift threatened high-risk projects with the potential to create medical breakthroughs. As the economist Gary Pisano observed, it also created a deficit of industry-wide capacity to learn from experience.
One strategy to avoid Govtech collapsing under a demand for high-velocity growth is to look to the state. In the Entrepreneurial State, Mariana Mazzuccato shows that public funding bodies have proven adept at providing patient finance to high-risk new industries underpinned by technological uncertainty through alignment with the missions of their investments, and a willingness and capacity to bet long. Public funds have consequently played a key role in the development of high-risk industries such as biotechnology. Public sectors constitute the potential buyers of Govtech products, providing revenue to cover ongoing costs. Independently of that fact, their funding bodies have the experience and capacity to be industry ‘builders’, furnishing capital to fund start-up costs and ongoing development. Performing this double function will also place them well to nurture a thriving Govtech ecosystem, connecting the different players within it, and ensuring it is thoughtfully governed.
City and national governments are beginning to channel limited public funding into Govtech. In 2016, the Israel Innovation Authority and Digital Israel jointly established the Digital Innovation Fund for Public Sector Challenges. The Fund offers recipients several grant options, depending on their stage of development. For Shai-lee Spigelman, CEO of Digital Israel, the criticality of the state as financial provider was clear from the get-go: ‘these are areas where it’s hard to get funding, exits are not as clear, and the sales cycle is very long when you work with governments.’ Companies repay the grant, over time, through royalties from sales if the project reaches commercialisation.
The argument that the Govtech industry requires patient financing does not exclude private investors (or not-for-profit investment bodies) from usefully and profitably funding Govtech ventures. As the Knight Foundation reports, Govtech provides the security of ‘a clear customer that can pay’ and ‘relatively defined benchmark metrics to look for when conducting diligence on an investment.’ Private investors, moreover, have begun to indicate openness to Govtech. OpenGov, a cloud provider for public sector budgeting, operations and citizen engagement, and ZenCity, focused on constituent feedback, are among Govtech start-ups to receive notable VC funding. Michael Eisenberg of Aleph Ventures counsels founders not to let ‘their perceptions about government dissuade them’ from public sector clients. Government procurement processes may be painful, he notes, ‘but B2B procurement is often slow, bureaucratic, and political too.’
To be sure, pockets of government, especially at city-level, can contract quickly. Yet however desirable it is for states to metamorphosize into faster moving beasts, and even with reforming will, bureaucratic processes rarely change overnight. For mission-oriented private investors and public funding bodies, the onus is on them to exercise agility, giving Govtech enterprises time to build public-sector knowledge and relations, and to grow on the back of them. In Govtech investment, patience is a virtue.
The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.
