Patient Capital, Urgent Mission: Paul Kwan on Funding Defense Innovation

Lauren Bedula 0:01 Welcome back to Building the Base. Lauren Bedula and Hondo Geurts here live yet again from the Reagan National Defense Forum. It's a beautiful day in Simi Valley. We've got a big lineup today. So here joining us right now is the one and only Paul Kwan, who's Managing Director at General Catalyst, where he leads the global resilience investment team. Paul, my sense is you've been at the defense tech space for a long time. I refer to you as one of the OGs. So thank you so much for coming on today, and we're excited to dig in. Paul Kwan 0:38 Yeah, thanks for having me. It's awesome to be in a physical pod, doing a podcast. Hondo Geurts 0:42 So Paul, you know, VCs kind of, lately have kind of become this mystique and much more, I would say, apparent in popular culture. How did you get into this? You know, when you're a younger Paul in high school, did you always was VC what you wanted to do or something? You fell into giving background but didn't know what a VC was back then, right? Paul Kwan 1:03 You know, I knew I wanted I wanted to be in technology and finance in those intersections. So that was pretty clear, whether it's, you know, doing things in the stock market and the like. And then I think it was probably in sixth grade, my mom bought me a copy of The Hunt for Red October. And so then that got me down the whole military defense interest as a civilian. So that was, that was that. Lauren Bedula 1:21 Love it and something we often like starting with, with the VC world. I heard it even today. It's like, DoW, the US government has trouble understanding what VC really is. And there are a lot of you here today at this forum. Can you give your quick take on what is it? What's the venture capital 101? Paul Kwan 1:38 Yeah. It's funny, because some people been asking us to write a piece on like venture capital for a GS 15, Gs 14 government person. And I think it's very, very different than private equity, which probably has had more experience in in the defense and government world. You know, at General Catalyst, this is our 25th anniversary, and our first defense investment was 21 years ago. So we do have some of that, that OG experience, but venture capital is so very different than private equity, right? We are taking high risk capital. We are funding R&D upfront in the hopes that a small percentage of these companies, a very small percent, can become big companies that can go public, can get bought. And so that's the whole mentality, and that is an economic and product and customer alignment that is very different than private equity probably, you know, not that. I digress too much more. But like private equity, funds are set up to be, typically five year, seven year duration. Venture capital funds are 10 years, so that right there you have an idea around duration, but it really is a different asset class, right? This we my message for that the government person is we are getting funded and paid. In the case of General Catalyst, a large number of our investors are actual state pension funds to deliver excess return, as distinct from the stock market as distinct from private equity, to find those companies. And so that's something that people didn't understand, that the economic flywheel of venture capital. Hondo Geurts 3:10 And I think another challenge is a lot of government folks think venture capital is synonymous with technology development. It's all just about technology development, where that might be an element, but not the only element you know, the so they kind of look as VCs as a way to fund research. Is that a good way to look at it? Wrong way to look at it? Paul Kwan 3:28 I mean, for sure, but there's so many ways to to drive impact and build value, right? So you got to have the sales. You got to have the customer value proposition. Technology, by itself, isn't going to sell honestly. The history, as most of us know in technology is that the best products don't always win, and win being definition value creation and impact. So I think that is a misperception. Hondo we need to kind of kind of punch through. I think there's also a misperception, this is back to that GS 15 piece in my head is, you know, small business and venture capital, right? Sometimes I think people think, oh, Small Business is great. We're funding jobs, we're funding innovation, but a lot of those companies don't quite get to the scale that you need in venture capital to really drive the kind of impact, resource wise, to make a bigger difference, right? So that's something that's important to understand, particularly, I think, with some of the government funding programs Hondo Geurts 4:20 Yeah. And I think you know what's, what's been nice is, and we'll talk some more of this momentum of VC investment is, there's also business reform. I mean, there's lots of other ways to drive growth that isn't purely technology based. And so I think sometimes government folks kind of pigeonhole them into, like, a new modernization capability, not like, let me revamp your back office, because they're 10 times more effective. Paul Kwan 4:44 But ultimately, if you think about like, what are some of the big, big challenges facing us as a nation? You need private capital. You need venture capital to step in and fund these things. These things are not, they're gonna take time. They're gonna take a large amount of capital. They're gonna need great teams to go, move move the mountain. And that's, I think, where venture capital steps in. And just think that's important for you to understand. Lauren Bedula 5:08 And I mentioned in our opening, just that you've been focused on the defense and national security space and broadly global resilience is how General Catalyst looks at it. What was that draw? I mean, for you personally, and then maybe for General Catalyst in terms of demand for this area? Paul Kwan 5:24 Yeah, so, so for me personally, you know, obviously I read a lot of stuff as a civilian, you know, going back to Tom Clancy in college, I had the chance to kind of roommates who enlisted and served. This is pre nine, pre 9/11 which was pretty interesting. I went to Wall Street, and I sat, actually, my first job on Wall Street. I sat in the bullpen an investment bank, and there was an airborne guy on the left and the Navy SEAL on the right. And so I got to understand all that, which was really, again, quite exciting. And then at General Catalyst, what's been great is bringing in veterans and advisors to kind of help us understand. Because I think you do have to have a deep level of understanding and empathy for the war fighter to do this work. You have to have a deep level expertise. Obviously, working with you all has been really helpful. There's some good markets. There's so many things are different than typical venture capital, right? And so that's, that's to me, is, is important, but the draw itself is, you know, there is, in our minds, nothing more important than modernizing our most critical societal industries, and for us, those are defense and government, industrials and energy, and those are the three pillars of our gold resilience. Hondo Geurts 6:35 So Paul, there's been a lot of talk here Reagan, or I'd say, over the last year or two, particularly, of, how do we re industrialize? Yeah, the DoD defense industrial base, but then maybe the country overall. What's your take, having watched this for a long time, on on the approach we need to do and and should we be thinking about it in the Defense Base and commercial industry separately. Should we look at it as we need to re industrialize so we can do both? What kind of what's your strategic view on re industrialization and onshoring to set us up to be ready, not only for like tomorrow, but for 40 years from now? Paul Kwan 7:17 That's it's a great question. We think about that a lot, Hondo, and I think there's a lot of focus on the defense capabilities, right, land, sea, air, space, cyber, supply chain, information warfare, right? And there's a lot of great innovation, a lot of great funding, a lot of great companies across all dimensions. But there's an equally important, if not bigger stack of things we have to build around manufacturing, software for hardware, for testing, the electronic supply chain, the energy supply chain, all of these things go into this industrial stack. And I'd argue we spend as much time thinking about those areas and funding those things as we do the capabilities themselves. Because as we know, we all know we if we can't make these things cheaper, better faster, it's not going to win in the end of the day. Lauren Bedula 8:10 And so you have worked, and right now, hundreds of founders, but over the history, I think, of General Catalyst's work probably in the 1000s, right? And I we often hear that technology is one thing, but ultimately, a lot of this is a human endeavor. What do you look for in founders and entrepreneurs? Paul Kwan 8:28 Yeah, it's great question. I think obviously everyone will have their own patterns and own filter. I think for us at General Catalyst, we're looking for really people who've shown a depth of journey to get to the stage. And so we are really, don't really care where you came from. We truly believe, you know, talent is everywhere. Opportunity is not. So we don't really care how you got to us in that dimension. And can give you lots of examples that. But we care about the depth of the journey you've been on, whether that's defense tech or whether that's, you know, AI or healthcare. And so once you understand that depth of that journey, then we kind of have to start thinking through like, Okay, have you thought through the, we talk a lot about, can you understand how the market will evolve for what you're going after. You may not be right, but you have to have some understanding of how it's gonna evolve so you can then react if you think that way. Those are the two things. And then, of course, we have the standard stuff, you know, Lauren, you know, team, technology. You know, obviously part of it's the pitch, but I mean those two things, your depth of journey to get to hear, and then, do you have a framework for how this will, this market will evolve? Are probably the two critical things that are hard to say but easy to appreciate when you see it. Lauren Bedula 9:51 And I'm going to flip to a kind of different version of that question, which is, you're coaching a lot of these folks too. So for your founders or leaders. Leaders that are looking to do business with the US government, primarily Department of War, national security, community, whatever it may be across the US government. Do you have any kind of off the hand advice for them that we can share with our listeners as well best practices for public sector business? Paul Kwan 10:14 Yeah, this might be a long answer. We might use it all the time. On this one, we think a lot about this. I think if you want to go build in defense of government tech, you need a level of empathy that exceeds most typical venture backed companies. You need a level of empathy for the war fighter. You need a level of empathy for the institutions, the incumbents and patience that is, is really orders of magnitude more. I mean, one of one of our biggest companies in defense tech, when most successful companies we work with that asked the CEO recently like, what's the biggest thing you wish you could change about the team right now? So I wish everyone could push their empathy up to a level of 10. Whatever goes wrong, it's always our fault, right? When we talk to war fighters who've been out there and seeing tech, it doesn't work, right? I have a number of, again, veterans on our team who say, Listen, this is the only industry in the world where the users of those products may willingly and freely sacrifice their lives to use that product. You better understand that, right? I don't think everyone does. And so again, there's a level of empathy and understanding to do this work that then allows you to do the work. And so, you know, these things, don't it's not quantitative. This is not like typical venture talk, but it is really important to us that you have a level of empathy and then you go get the education you need. Hondo Geurts 11:39 So speaking of a depth of journey? Yeah, you know, we're on, I would say this journey between Defense Department, defense tech, public sector and VC, and a lot of very positive momentum, I think, a lot of acceleration, a lot of excitement. How do you see that playing out in the next five to eight years and and I'll flip the empathy question. How should the government customer be thinking about VC and how to best leverage them to get a mutual outcome that's good for both parties? Paul Kwan 12:12 I think you almost answered it the first there, Hondo, that it's gonna be a long journey for all of us. And I think there's a lot of heat, there's a lot of excitement. I think for the I can speak for the private capital industry, we just need to be, we had to have a level of patience. Understand this is gonna take 5-10, years, right? And so we can't just get frustrated with the next, you know, government shutdown. We can't get frustrated with, you know, the budget. So we just have to, as a private capital universe, understand that, I think for the government constituents, I think we have to, we still have to do more on education. There are a number of interesting externship programs that got shut down by the DoD that would put, you know, active duty people into tech. We need more of those things, again, to drive that cross cross understanding. And we need to, hopefully, today, you know, and this year, pull through on the acquisition reform and not have that get stuck. Because, you know, there's a story I have about that, but like, acquisition reform, you know, is primed to make some big changes, but we have to fall through. Lauren Bedula 13:15 So tell us that story, because I think you were recently at Secretary Hegseth's remarks, where you give the speech about acquisition reform. And really it was a call to action. Now, what was your impression? Paul Kwan 13:25 Yeah, obviously, you know, the November 7 speech from Secretary Hegseth around acquisition reform was well covered. I had the privilege to be in the room. Me and my team wanted to stand up and cheer and clap. It was that great of a speech. The content all that. And it's funny, because nobody actually stood up and clapped and cheered. And I was talking to a colleague of mine who was and by the way, in the heck says speech, you know, he, he referenced a Donald Rumsfeld speech from September 10. You can, you know, the readers can look it up. So I spoke in one of my colleagues in this person had been in the room 24 years ago for the Rumsfeld speech on September 10 about acquisition reform. And he said to me, Paul, I felt like standing up and cheering as well, but when, when I walked out of that meeting, couple people around me said, nothing's going to change September 10, 2001. So I just, I think now's the moment, right? You know, all of us here, we need to come together and really fix this acquisition form so we can do the modernization. We need to advance the agenda. Hondo Geurts 14:35 So as we kind of finish up here, Paul. You know, we got a lot of young listeners who are grinding away. We got a lot of senior folks that have been grinding for a long time like you have. Oh, you always come off every time I see you, is fired up and excited, and you know, you don't let you know, minor setbacks get you down. Any tips you'd share with with listeners on how to stay resilient on these long journeys and how to kind of keep the long, long goal in mind and not kind of let frustration get in the way of forward progress? Paul Kwan 15:09 You know, I think these, if you look at the technology industry and innovation, there are a couple industries where we just haven't had the chance to modernize for a whole host of reasons, right? It just so happens these are coming to the forefront. And if we can fix these industries again, the industrial sector, the power sector, the defense government Tech, we didn't talk about non defense gov tech, really hot area, right? How do we fix the whole front office of government? I mean, these are amazing opportunities to really transform our societal infrastructure and fabric, and you don't have that chance very often. We couldn't have done it 10 years ago. The technology wasn't fully there, right? And so now we do. And so that's exciting, guys. It's like, it's why you guys do what you do, right? This is really the time. We just have the technology catalysts and we have the capital. The question is, do we have the will and the drive to make these changes? Lauren Bedula 16:04 Love it, and I have one more, just like on the the outlook here, yeah, as we talked about, there's so much private capital, I think, being pushed towards this issue, which is exciting even we started this four years ago, really wasn't the case at all. So just the momentum in the past few years has been incredible, and really, month by month, even this year, is this going to end? Or as a VC, what do you look for? You still have LPs to be accountable to, or investors, what's what's the return? What's the outlook here? Paul Kwan 16:33 So you know, as we said before, venture capital has a much longer duration than private equity. So right off the bat, we can think longer term, which is great, but we have to have the education back to the education point that it's gonna take a while. Yeah, right. You all know better than anyone, right? And so once you have that mindset, then we can get there. But don't expect us to be like AI software companies that are going to go, you know, exponential off the curve. We have to make things, right? Making things, building things, takes time. But I think for what's lost in the shuffle is like the size of the dollar spend, right, as you know, right, if we go into $900 billion in us, defense spending, and we have half a half a trillion in Europe, right? That incremental new dollars spent, if it goes to 10, 20, 30% to new tech, new innovation. That's a massive opportunity just in government alone. So again, let's not lose track of the prize and the opportunity to transform things. Lauren Bedula 17:30 Yeah, and I'm sorry, I can't help but pull this thread a little bit too, because I'm curious to see if you have an outlook on what exit activity would look like. Do you anticipate a lot of M&A here? And then a second component to that, I often hear this misconception that when you see a company with a significant raise on the customer side of reaction, hey, they've got all this money. Why do they need ours too? So can you just talk about some of those quick dynamics, like exits. Paul Kwan 17:53 Great question. I think people, you know, like, early on, and you know, we were, like, one of the earliest investors in Anduril, right? And if you look go back a few years, people always Oh, like, how big can it be when Lockheed Martin is this and trades at this multiple of that, and it's a it's an apples and oranges thing, right? Airbnb doesn't trade like a hotel company. Uber doesn't trade like a car company, like a rental company. So you understand, for those who are kind of looking at technology disruption for the first time, that's these are all first of a kind companies. When you have a first of a kind business model, it is a new thing. Have you all experienced in that market? But, like, we don't really worry too much about that. And again, I'm not even talking about Palantir's current valuation or the like, I think there's massive room for exits. If you track some of the recent space IPOs, they've been really successful, even though space is a hard market. You know, what's going to be the reception for some of these Neo primes? It's going to be pretty good. Back to the the other question, which is, if the customer sees a big fundraise, it, it is a reflection that the private capital market is saying that company is going to get contracts. Just to be very blunt, when a company raises a big round from VCs, you can assume the market, the private market, is expecting, and assuming large contracts will come through, is not the reverse. And if those contracts, they'll come through. Then it's not going to be the innovation flywheel doesn't work because we, the private sector, put up all the capital to build those products, not taxpayer money, right? Again, it's worth saying once more time, private capital, venture capital, funds, all the R&D funds, all the products, and not to taxpayers in this model, unlike the traditional model. And then when you see a big raise, it's basically saying, Okay, we think they're going to get a big contract if it doesn't come in, then that's not not that's not status quo. Lauren Bedula 19:53 Thank you and Paul, thank you so much for coming on, sharing your story, sharing these valuable best practices, but also helping Hondo and I and our listeners really learn about this space. Paul Kwan 20:02 Thanks for having me. Transcribed by https://otter.ai