Palantir — A Federal Market Lesson For VCs

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Thanks to its work with the U.S. government, Palantir went public nearly six months ago at a valuation of about $22 billion. According to Palantir’s SEC filing, just over half of the company’s revenue came from commercial customers and the rest from U.S. and foreign government work, with government contracts making up $345.5 million of Palantir’s overall revenue in 2019. 

Clearly, Palantir’s investors saw big returns from the company’s work with the U.S. government. Yet venture capitalists continue to be wary of the federal market.

VCs view the federal market as a potentially costly distraction for fast-growing startups, especially given the long timelines to win contracts. Adding to what AFVentures co-founder and Managing Partner Jason Rathje gathered in his research at Stanford, VCs fear the delayed returns, uncertainty in follow-on contracts, IP battles and the public scrutiny that comes with government contracts. Many VCs want to invest only in companies that already have government contracts. 

Years ago, when Meagan Metzger was founding Dcode and talking to VCs, they told her repeatedly that the federal market was potentially attractive for their portfolio companies but too hard for startups to go after alone. Now, startups frequently ask Dcode how they can best make the case to potential investors about the value of their federal revenue. While the government market isn’t easy, VCs should rethink the ROI for their portfolio companies.

The U.S. government knows VCs don’t love when their portfolio companies chase federal dollars, so they are trying to make the market more enticing. The Air Force’s AFWERX office smartly expanded its Small Business Innovation Research (SBIR) program to grant awards to “dual-use” commercial tech companies to help top tech companies break into the Department of Defense. A few years later, however, we’ve heard from the venture community that winning a SBIR is no longer a promising indicator that a tech company will be successful in the federal market because transitioning to larger contracts and more sustainable work has proven difficult. 

Winning an SBIR is like earning a hunting license, which also is the case with other federal contract types. One thing you can count on in the government market is that no federal agency or program office wants to be the first to buy the new, hot tech. But once a startup has a foot in the door with a first contract, and the right follow-on strategy, it can capitalize on that to expand its foothold. Which is exactly what Palantir did.

VCs should look at Palantir’s story and realize the opportunity to fund what could be the next big success.


Takeaways for VCs

Palantir’s return on investment shows the federal market is worth your while. The Joint IED Defeat Organization awarded Palantir one of its first contracts in 2006, and leveraging early contracts like that, Palantir expanded its government from eight pilots to more than 50 programs over the next few years. As early as 2013, investors were valuing Palantir at 20x its revenue when the company was working with at least 12 U.S. government agencies like the CIA, DHS, NSA, FBI and CDC. Proving, there can be a winning formula with huge ROI for investors.

For VCs looking to replicate Palantir’s success and identify portfolio companies that may have federal applicability, it’s important to remember that the problems at a Fortune 500 company are not dissimilar to most federal agencies. Startups that offer enterprise software products, enabling workforces to leverage best-in-class private-sector technology, are usually a good fit for the federal market.

While Palantir spent significant time and money getting to its first federal contract and leveraging it to multiply success, there are low-touch ways to test the waters without a dedicated federal sales team.

Many VCs and tech companies have partnered with Dcode to assess the high-potential upside of the federal market. For example, automation technology startup Hyperscience is seeing increased demand for its offering within the government market, as well as continued investor support. The company raised $140 million last year, led by Tiger Global and Bessemer Venture Partners, and expects roughly one-third of revenue to come from the public sector this year (disclosure: Dcode Capital was a co-investor in Hyperscience’s Series D).

Hyperscience’s Chief Operating Officer Charlie Newark-French, said: “Recent changes are straining federal agencies’ legacy systems and processes, shifting their digital transformation needs. The federal market is pivotal to our growth as a company, and working alongside Dcode, we’re helping agencies become more agile and better serve Americans.”

As Palantir’s growth and exit proved, federal revenue can lead to rapid growth and significant returns for investors. Government revenue is too often discounted or ignored by VCs, but it presents a massive opportunity for the right tech companies with the right federal strategy.

Rebecca Gevalt, tech managing director at Dcode

Rebecca Gevalt is the tech managing director at Dcode, which breaks down barriers between commercial tech and the U.S. federal government. Gevalt leads Dcode’s acceleration program for tech companies looking to scale in the federal market, and is a managing partner of investment network Dcode Capital, funding tech companies that can move our country forward. Prior to Dcode, she worked at the Central Intelligence Agency with In-Q-Tel to bring novel tech startups into the national security space. She holds a BS from Tulane University.

  • Originally published May 6, 2021, updated May 12, 2021