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[NYTimes] December 30, 2001 Suddenly, Uncle Sam Wants to Bankroll You By AMY CORTESE It may be quiet these days in Silicon Valley, but don't tell that to Gilman Louie, the chief executive of In-Q-Tel, a private nonprofit venture capital company set up and financed by the Central Intelligence Agency in late 1999 to get a better bead on innovative technology the intelligence crowd might put to use. Since Sept. 11, Mr. Louie's staff has fielded calls from over 400 companies - more than four times the normal volume for a three-month period. And the calls are bringing in results. At the invitation of I.B.M. (news/quote), for example, In-Q-Tel executives visited the company's vaunted research labs and are now negotiating rights for the C.I.A. to use some of its technology. All told, 60 companies, mainly start-ups, are on what In-Q-Tel calls a fast track for further investigation and possible investment. Nestled on Sand Hill Road in Menlo Park, alongside Kleiner Perkins Caufield & Beyers and other big Silicon Valley venture firms, In-Q-Tel has mainly been viewed as a curious government experiment in working with the private sector in new ways. But the attacks of Sept. 11 and the resulting anti- terrorism campaign have given the firm a new sense of purpose. "This is no longer an experiment but a necessity," Mr. Louie said. "The government can't afford to build these technologies alone anymore." In-Q-Tel is just one example of the government's new willingness to tap into the private sector for help in finding and quickly bringing to market the technologies with national security uses. For now at least, the old "skunk works," government-backed research operations owned by big military contractors, are giving way to a more open model that views the marketplace - particularly the start-ups financed by billions of venture capital dollars - as a sprawling R.& D. lab. In October, the Defense Department issued a broad call for technology that can help fight terrorism, like software that can identify faces from a video or predict terrorist actions and behavior by using remote sensor technology. By the end of November, the agency had received more than 700 submissions, and by the deadline on Dec. 23, an estimated 12,085 had flooded in. Recently, the Army began considering the creation of a $50 million venture fund modeled after In-Q-Tel. And staff members from the Office of Homeland Defense, run by Tom Ridge, and its Office of Cyberspace Security, headed by Richard Clark, have been meeting with technology start-ups and research and development labs across the country. "The government has really been reaching out and saying, `These are the areas we are interested in,' " said Roger Novak, a partner at Novak Biddle, a venture firm in Bethesda, Md., that invests in early-stage companies. "What Sept. 11 has done is to mobilize government and industry in ways that I haven't before seen." That is good news for cash-hungry start- ups with technology that can be applied to the military and national security. Many start-ups are realizing that, beyond providing financing, the government can also be a lucrative customer - especially in a time when information technology spending by corporations has all but dried up. In the past, fledgling technology companies tended to avoid government work. They were unwilling to hitch their future to a single customer, especially a slow-moving one synonymous with red tape. But now many are pursuing new military or related uses for their technology. "The needs of the federal government are not that much different from a private company, but they need it today, and they're willing to spend money on it," Mr. Louie said. He figures that 80 percent of the companies In-Q-Tel has backed had never before dealt with the federal government. One company eager to be a supplier to the government is @Road. Based in Fremont, Calif., it has been selling its wireless Global Positioning Service to corporations that want to improve their management of mobile work forces. The technology can track the position of a vehicle or other object over wireless networks, allowing a company to monitor its delivery fleet, for example, and automatically alert customers when a delivery is on its way. Krish Panu, chief executive of @Road, suggested that the same technology could help in national security, perhaps monitoring vehicles that transport hazardous materials and alerting law enforcement agencies when a truck deviates from its scheduled path. In the last several weeks, @Road has demonstrated its technology to airport authorities in San Jose, Calif., to the Department of Transportation and to Congress, and it hopes to be involved in some pilot projects. Mr. Panu said the need for security-related technology offered both a business opportunity and a social responsibility. On the financing side, it has no doubt helped that the traditional venture capital industry, which has been focused on salvaging existing investments after the dot-com bust and the near closing of the capital markets to initial stock offerings, has been relatively inactive this year. VentureOne, a venture capital research firm, counts just 26 investments in security-related companies in the third quarter out of a total of 161 investments in software companies. Preliminary data for the fourth quarter show just 19 security-related deals. But venture capitalists say that is changing. "As the needs of the government come more into focus, there's no question in my mind that venture capital companies will be backing companies whose technologies are needed by the government," said Floyd Kvamme, co-chairman of the President's Council of Advisors on Science and Technology and a partner emeritus at Kleiner Perkins Caufield & Beyers. Ted R. Dintersmith, a partner at Charles River Ventures in Waltham, Mass., said venture capitalists had initially responded to the attacks on a personal level, not as a business opportunity. But the fact is that venture capitalists "have the skill set and capital to help counter" terrorist threats, he said. Mr. Dintersmith, who has been poring through books on germ warfare like "Germs" and "Living Terrors," says the private sector in general and venture capitalists in particular are well positioned to back the technologies needed to defend against terrorism, especially as boundaries blur between national and private security. "There are some fundamental things we can do long term to help," he said. Most venture firms will not be rushing into areas outside their expertise or into companies that do not have long-term growth prospects - they learned that much from the dot- com bust. But it is increasingly clear that there are opportunities for companies making a broad range of technologies that fall loosely under the security banner. "There's a tremendous amount of interest in security companies, data-mining companies and intrusion detection," Mr. Novak said. His firm, which has close ties to government and university research labs, sat out much of the dot-com era, doing just three deals in all of 2000. This year, it has done five and is in advanced discussions with two more companies, including one based in New York that makes a new type of intrusion-detection software. Much of this technology is not new, of course. Companies that provide encryption technology, firewall software, anti-virus programs and biometrics - identifying individuals based on unique characteristics like handprints or facial features - have been backed by venture capitalists for years. But new twists on some old ideas are needed to keep up in the arms race against terrorism. In May, Charles River Ventures, along with Sequoia Capital, New Enterprise Associates and other investors, put fresh money into Guardent, a Waltham, Mass., company that provides security software and services for corporations. As they - and the government - grow ever more dependent on computer systems, monitoring of electronic intrusions or suspicious behavior on a network is growing in importance, too. Guardent's software technology is especially useful because it can monitor security intrusions across a variety of networks and discern patterns. That could help determine quickly whether or not the government or the country's communications systems have been subject to a coordinated electronic attack. Perhaps the area of greatest interest, for law enforcement agencies and investors alike, is technology that can help analyze vast volumes of data and detect unseen patterns or abnormalities. Called data-mining or knowledge management, it has a wide range of applications in areas from preventing credit card fraud to sifting through F.B.I. data. As the Sept. 11 attacks pointed out all too painfully, the federal government could do a better job of scrutinizing and sharing the reams of data its various agencies collect. Law enforcement, said Mr. Louie of In-Q-Tel, has traditionally been an investigative function. "Now we are asking them to anticipate and prevent," he said, "and that requires a set of analytical capabilities that these agencies have some of, but need to take to a new level." That is why In-Q-Tel has shifted its focus to knowledge management since Sept. 11. As Mr. Louie explains it, most analytical software today is based on a query - a user submits a question or a subject to be searched and receives a response. The problem is, "you have to know the question," he said. "We're at a point where intelligence services might not even know the question to ask," he added. "How do you put together the puzzle pieces when you don't know what the picture is supposed to look like?" Seven of the 22 companies in which In-Q-Tel has invested are working on problems of managing large volumes of data. One such company, Tacit Knowledge Systems of Palo Alto, Calif., makes software that tries to understand the many different users in an organization and the information that each needs - and then route that information automatically. Another recipient of In-Q-Tel investment, Stratify Inc., known until recently as PurpleYogi, helps categorize and manage "unstructured data" - information contained in e- mail, documents and Web pages that falls outside of a database and typically constitutes the bulk of an organization's informal expertise. In-Q-Tel invested in both companies in November, and the C.I.A. is using their products. With technologies like these, Mr. Louie envisions a software system that could monitor e-mail traffic from various sources and identify patterns from these disjointed pieces: a person's name, a location or even a topic - say, flying lessons. Then the system would ensure that the information was sent to the right people. The government interest in security technology has opened financing options and new markets for start- ups, but dealing with the government can still be a long, arduous process. Quorex Pharmaceuticals, a company developing drugs that thwart bacterial infections, including anthrax, by knocking out an organism's ability to launch a biological attack, provides one example. The company raised $30 million during the spring and is now raising more money from private equity sources. Quorex's chief executive, Robert Robb, said the company might be eligible for some federal funds designated for research and development related to internal security. But, he added, the money was still the subject of wrangling by government agencies. "The important thing is that they find a way to disseminate the funds as rapidly and effectively as possible," Mr. Robb said. In the meantime, he added, "we have to move ahead as though that will not materialize." TILL, young technology companies may want to negotiate the governmental red tape. Over the years, the Defense Advanced Research Projects Agency, for example, has financed research that spawned the Internet and the Stealth bomber, among other innovations. Known as Darpa, it has roughly $2 billion appropriated each year to finance promising research. Yet "there are a lot of small start- ups with very good ideas that didn't even know that Darpa existed," said Frank Fernandez, a research professor at Stevens Institute of Technology in Hoboken, N.J., and director of Darpa from May 1998 until last January. Darpa, as the research and development arm of the Defense Department, dispenses the equivalent of venture capital without the equity stake. "If you're a small company," Mr. Fernandez said, "it's the best deal in town." And when deals are scarce in Silicon Valley, entrepreneurs are bound to take note of every possibility on offer.
