Op-ed | What the government should or should not do to help space industry

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One way to help the industry is for the government to communicate what problems it needs solved and commit funding for the right solutions.

The COVID-19 economic slowdown will have lasting implications on the new space sector. Yet the United States cannot afford another lost decade of commercial space innovation. Adversaries are building their own space ecosystems, one of the few areas where America was widening the technological gap before the crisis. They are also targeting existing U.S. space architectures.

Commercial space firms are not a major source of job creation or gross domestic product, which is why it is challenging for Congress to issue a more systemic bailout. They are, however, an engine of American ingenuity and provide critical national security capabilities. On this account, the government needs to play a role in ensuring their long-term success.

Many commercial new space firms pegged their future success on customers from some of the hardest hit industries like airlines or maritime logistics, and on continued access to venture capital. VC has been the lifeblood of the new space sector and many commercial space firms will fail as capital recedes.

Launch and commercial small satellite constellation providers are expected to be hit the hardest, reinforcing one another’s demise. This presents a critical gap for the government that bet on these two sub-sectors. Space infrastructure firms may see the quickest demise, given the time horizons of their business models. Imagery and analytics firms may fare best, given their typically asset light business models.

In some ways the current stress on the sector is accelerating an inevitable market correction. Too much capital was funding an overcapacity of supply, as evidenced by the bankruptcies of LeoSat and Vector that occurred before the pandemic. As with any nascent market, commercial space would have seen more failures and consolidation along the way, but these natural market ebbs and flows are being exacerbated by the expected length and severity of the current pandemic.

Returns required by investors

Venture capital is expected to flee not because space is a hard problem, but because absent large-scale commercial demand it will be challenging for it to generate the types of returns that are required by its limited partners.

Limited partners provide the funds VCs invest and manage. They can be institutional (like pension funds), national (sovereign wealth funds), family offices, or wealthy individuals. Economic downturns often place immediate pressure on the VC business model and, in turn, the companies that are dependent on this critical source of capital. As a result VCs become much more selective about which investments they make. Business plans are much more closely scrutinized during and after a downturn than before. Additionally, over time, limited partners typically diversify from higher-risk sectors and from VC more generally.

On average, limited partners expect to make an 8% annual gain on their invested capital, in addition to the 80% return on any earnings made upon the sale of the company or the VCs exit from the investment. VCs can keep the rest. While this model generates considerable wealth when it is successful, there is no hedge against losses that can often be absolute to VC firms and, more importantly, their limited partners.

The opportunity of the commercial space market was estimated to be in the trillions by 2040. This attracted a lot of VCs that wanted to beat the already high market expectations of their investors. They are now incentivized to exit. But that is okay.

Venture capital fuels innovation in return for wealth. It is the proverbial tip-of-the-spear of capitalism and should not be treated as a scapegoat for the space market’s expected decline. Without it “new space” would have never existed, and in due time it will once again play a pivotal role.

Lessons for all

The current crisis will teach many lessons to space startups, investors, traditional suppliers and the government. As with the previous generation of space market failures punctuated by the oft-cited bankruptcies of Iridium or Teledesic, tomorrow’s space firms are likely to be more focused on working with the government or being critical partners to more established supply chains. Eventually the dreamers will return, but the survivors of the current crash will be focused on having business cases that close in 2 to 5 years, as opposed to 10.

Investors that shunned government exposure or steered their companies away, due to the relatively limited financial return profile, will make it a priority. Those who were not prudent in their business model diligence or accepted unrealistic return horizons will tighten their scope and help guide founders to more tangible results. VC “tourists” — funds that are not specialized in the space sector — are likely to stay away for a generation, making it easier to build an ecosystem of viable and resilient suppliers with experts at the helm.

An opportunity will emerge for established government contractors and some new entrants to introduce the capability that the commercial space market has proved too fragile to deliver. Firms with adequate resources and strategic forethought will have a historic prospect to deliver a needed capability, while potentially serving as a bridge between the economic promise of space and its reality.

The Pentagon and NASA are acutely aware of the challenges space startups face today and are proposing a series of emergency measures. This could inadvertently bolster businesses that are not meant to survive. In areas where accessing commercial business models is meant to be a core value proposition, the government should avoid permanently anchoring to firms that never achieve this scale.

For years the government built-up an infrastructure of innovation outposts via which to reach the commercial sector. Many continue to demonstrate success. This innovation sourcing archipelago should not be misused for bailouts. Neither should the government accelerate funding to consortia or drive investment via any number of alternative contract vehicles and acquisition offices without a more robust long-term plan. This type of investment will neither be large enough to save the sector, even if saving it was warranted, nor would it be able to replace fleeting VC investment, becoming a potential sunk cost for the taxpayer.

Government’s key role

While the government should not play the role of the invisible hand, it does have a responsibility to bolster the economy where it can and to protect critical sources of supply. The government can ensure the long-term success of the innovation ecosystem by focusing on having more programs and competitions and supporting transitions from development to program of record.

Venture capitalists have already lent their voice, they’d rather see the government focus on letting more contracts, not innovation prizes. The government should continue to lead with a bold vision for space and incentivize industry with its full purchasing and competitive power.

Firms that survive this crisis will be financially viable, diverse across industries and customers, and good stewards of national security capability. This is not a time to despair, but a time to commit to generational changes, to incentivize programs that are structured to provide a level competitive playing field, to demonstrate a budgetary commitment that goes beyond the headlines and the poster-sized checks, and to message to industry what problems the government needs solved and its funding commitment for the right solutions.

Mikhail Grinberg is a principal at Renaissance Strategic Advisors, a consultancy in the aerospace, defense, space, intelligence and government services industries. He is also an adjunct senior fellow at the Center for a New American Security.