Don’t Jump on the Public Sector Bandwagon Unless You Know How to Ride

A group of people standing under a "bandwagon" sign, and one person standing under a "bus" sign.

Venture firms are notorious for jumping on bandwagons. Sometimes they are right to do so, sometimes they are just naïve, and sometimes they are trying to distract from their poor performance elsewhere. At SineWave, we built our own wagon almost a decade ago, and built the first private sector venture fund to focus on bridging the gap between Silicon Valley startups and the public sector. And we’ve solidified our leadership and ownership of this space, having outperformed most of the industry and having delivered top 5 percentile returns to our investors. But despite our performance, the public sector has never been a popular bandwagon, primarily because few understand it, and even fewer know how to drive returns from it.

Most recently though, it seems that every major venture fund is trying to hitch their horses to the public sector in some way. As a result, there has been a proliferation of rhetoric and investment around “defense tech,” “American exceptionalism,” “national security,” and “govtech.” While I’d love to think SineWave’s top 5 percentile returns have something to do with it, the more likely culprits are self-preservation, shiny object syndrome, hubris, and naivete. Let’s address them in order, since that’s how they often appear:

A year or so ago, many venture funds were forced to confront the reality that 50x multiples do not sustain themselves over time. And when they raise billions of dollars a year, and are personally incentivized to continue raising even more, financial discipline is not a luxury they can afford. So, when the bubble inevitably bursts, which they always knew it would, they distract Limited Partners from the mess with a new shiny object to convince them to repeat their mistakes and funnel them more capital.

Shiny Object Syndrome
Everybody loves a little bit of sparkle. And when the luster of the private sector fades, the public sector often steps in to fill the shiny object void. Why? Because the public sector, already the largest buyer of technology in the country, will consciously act as a protective, economic counterbalance by spending even more money than usual. And when the public sector spends, it spends in the billions. That’s a lot of sparkle – enough to draw the attention of any investor.

At SineWave, we clearly believe that the public sector is a massive opportunity. It is always a shiny object, and startups can establish a meaningful competitive advantage if they pay attention. But to do so requires significant expertise. You need to be able to translate Valley speak to government speak, understand the needs of the public sector and how to meet them, navigate its complex systems, and know how it operates as a customer, to win revenue for a startup. Most of the firms newly embracing the public sector as an investment vertical have never set foot in the office of a government operator, and even more concerningly, don’t think that matters. Investors and entrepreneurs expound the importance of “knowing your customer,” but rarely spend the time to do so.

Great investors are experts in pattern matching. But while often necessary, such expertise is rarely sufficient. And certainly not when dealing with the public sector sandbox, where both the rules of the game and the players in it are unique, complex, and often intentionally opaque. It’s a different kind of playground, and if your skills don’t extend beyond the Valley, you’ll quickly find yourself drowning in quicksand.

Most of the investor rhetoric around the “public sector investment opportunity” suggests not only a lack of expertise, but also investment theses that suffer from fundamental flaws. At SineWave, while we are leaders in bridging the gap between entrepreneurs and the public sector, we do not invest in defense tech, national security, or public sector specific technologies. These companies are rarely compatible with the venture capital model – specifically, a focus on driving outsized returns on investment. Why?

First, the public sector can be a complicated buyer, and in many cases, sales cycles are long and lack transparency. This introduces many risks, especially revenue uncertainty and unpredictability. In turn, this creates significant financing risk. There are few private sector investors who understand the public sector enough to know or trust whether a startup will successfully weather these obstacles. Every day, great companies fail because they cannot raise money. This problem is particularly pronounced in the govtech space. That is why, at SineWave, we invest early in companies like Databricks and SentinelOne, where the primary focus is building a robust commercial business. Alongside that business, SineWave can then guide the company in augmenting their commercial base with significant public sector revenue, rather than relying on that revenue to succeed.

Second, exit opportunities for govtech companies are limited to either acquisition by a handful of system integrators, often referred to as the Beltway bandits, or to a rare IPO. And the multiples for these acquisitions and IPOs are rarely above the 1-2x revenue range. While there can be exceptions, this is not the world of 10x or more software multiples that drive the kinds of returns that venture capital demands.

The Punchline
We are proud of the storied careers of our teammates who have served the public sector by bringing new, innovative technology to bear on our nation’s most pressing problems. At SineWave, we too believe that building technology to serve the public sector is a laudable and noble cause. And we support all efforts to help entrepreneurs on that journey. But that does not mean this also makes for a smart venture capital investment thesis.

We often say at SineWave, the public sector is not one entity; it is like its own Fortune 500 – many massive enterprises combined, each with different goals, needs, and means of execution. Subtle distinctions easily escape even the most established VC firms. But subtleties matter when investing in the public sector.

The dynamics discussed above are not a new story. And they are unlikely to have a particularly unique ending. Ultimately, the tides will change, and the VCs currently rushing into the public sector will rush out just as quickly, many having lost their shirts in the process. The few who learn to properly hone their investment thesis to capably navigate the public sector will still be able to drive outsized returns, and are welcome to join that SineWave bandwagon. For those still debating it, we recommend that you not jump on board until you know how to ride. Faceplanting in horse poop is not fun.