Office of Strategic Capital: Attracting and Scaling Private
Capital for National Security
In December 2022, the U.S. Secretary of Defense established the Office of Strategic Capital (OSC) to attract and scale private capital investments in critical technologies vital to national security. These critical technologies encompass fields such as nanomaterials and metamaterials, bioenergetics, synthetic biology, Open RAN (FutureG/5G), integrated sensing, microelectronics, quantum science (computer, security, sensing), battery storage, and space-enabled services. These sectors often demand substantial investments but struggle to secure capital due to their long-term horizons, lower profit margins, and higher technical risks.
To bridge the gap between the availability of venture capital and the needs of small businesses in their initial and growth phases, the U.S. Government has leveraged the Small Business Investment Company (SBIC) program. This program licenses and regulates privately owned companies through the Small Business Administration (SBA). The SBIC program, particularly through its loan initiative, provides government-backed loans to equity investors, allowing them to invest in sectors of national security concern.
For instance, in 1975, the SBIC program’s investment of $500,000 in Cray Research enabled the development of the CRAY-1 supercomputer, a project that was struggling with product delays, limited market prospects, and sluggish capital markets. This initial funding stimulated additional investment, ultimately bringing in a total of $2.3 million and bridging the “Valley of Death” to sustain Cray Research’s development.
The SBIC program supports businesses through both debt and equity financing. For debt, SBICs can offer loans ranging from $250,000 to $10 million, with interest rates typically spanning from 9% to 16%. When it comes to equity investments, SBICs can invest directly in businesses in exchange for a share of ownership, with typical equity investments ranging from $100,000 to $5 million. Additionally, the blend of debt and equity financing provides flexibility, allowing businesses to secure the necessary capital while balancing their funding strategy. For these combined debt and equity offerings, loan interest rates generally fall between 10% and 14%, maintaining the investment range of $250,000 to $10 million.
Investment Strategy
The OSC’s investment strategy involves leveraging finance — using debt to amplify the equity return profile. This approach combines government loans and loan guarantees with private capital in collaboration with other federal agencies. Private investors, in partnership with the SBA, form licensed limited partnerships mandated to invest in these critical technologies. Profits exceeding the repayment of government-backed loans are distributed among the general and limited partners.
To sustain and enhance these efforts, the SBA has partnered with the Department of Defense (DoD) to launch the Small Business Investment Company Critical Technology (SBICCT) Initiative. This initiative aims to bolster private capital investment in technologies that are pivotal to both economic and national security. Managed by the SBA’s Office of Investment and Innovation (OII) in collaboration with the DoD’s OSC, the SBICCT Initiative merges the SBA’s proven track record with the DoD’s deep scientific, technical, and security expertise.
A key financial instrument within this initiative is the Accrual Debenture, which is structured for extended durations, allowing interest to accumulate and be payable at the loan’s term end. According to Congressional Research Service and Troutman Pepper, the SBA proposed the Accrual Debenture because it does not believe the standard SBIC debenture is aligned with “the cash flows needed for patient capital strategies solely investing in the equity of small businesses.”
As proposed, the Accrual Debenture would accrue interest over its 10-year term, which would then be added to the principal at the end of the term, with the SBA guaranteeing all principal and unpaid accrued interest. As a result, no interest payments would be required until the end of the term. This is in contrast to the standard SBIC debenture that requires semi-annual interest payments to investors.
If an SBIC that issued an Accrual Debenture cannot pay the principal and accrued interest at the end of the 10-year period, it can apply for a rollover Accrual Debenture, which has a five-year maturation period. The maximum amount of leverage that an SBIC can have outstanding will be the aggregate of the total principal leverage plus 10 years of accrued interest on the principal. Accrual SBICs are required to invest at least 75% of its total financings in equity capital investments, typically own 50% or less of the small business concern at initial financing, and elect at the time of licensing to issue Accrual Debentures.
Execution of Investment Strategy
The initial prioritization phase focuses on evaluating enabling technologies that support multiple Department of Defense (DoD) priorities, requirements, and programs. This involves assessing the market share of these technologies and determining whether the U.S. is losing ground or maintaining its position relative to global competitors. Key considerations include the need for strategic capital — whether public support is essential to attract private investment in areas crucial for national security. Additionally, the evaluation considers the potential security impact of investments, specifically how they might enhance the development or scaling of critical component-level technologies and secure access to vital supply chains for the United States and its allies.
Once the prioritization is complete, the team will focus on utilizing specific financial tools to commercialize and scale critical component technologies. For earlier-stage technologies, DoD prioritizes OSC investment in industries with a promising innovation advantage, as measured by a strong base of intellectual property, indicating potential for growth. For later-stage technologies, the approach prioritizes OSC investments in industries with an overall manufacturing disadvantage relative to global competition but nevertheless have the potential to scale production within the United States.
The final step is accounting for complementary programs within DoD and other federal departments or agencies. The DoD collaborates with other federal departments and agencies to identify areas of mutual interest and potential overlap in commercial investing activity and seek alignment or deconfliction where necessary. The Strategic Capital Advisory Council, co-chaired by the Under Secretary of Defense for Acquisition and Sustainment and the Under Secretary of Defense for Research and Engineering, promotes collaboration where OSC activities intersect with existing equities and authorities amongst their respective subordinate organizations.
Transition Acceleration Program (TAP) Activity
Along with loan guarantee programs, OSC intends to launch the Transition Acceleration Program Activity, eyeing “out-year” DOD research, development, test and evaluation funds to possibly team with private capital investors to co-develop critical technologies. Currently, programs like Tactical Funding Increase (TACFI) and Strategic Funding Increase (STRATFI) combine Small business innovation research funding with private capital to co-fund technology development as it transitions to requirement owner or program office.
Syndication of Agencies
Partnering with the Department of Defense (DoD) is essential for maximizing investment potential in critical technologies. The Investment Policy Statement outlines various government-backed services designed to enhance capital leverage. One such service is access to cybersecurity resources from the National Security Agency (NSA) Defense Industrial Base (DIB). Through the NSA’s Cybersecurity Collaboration Center (CCC), eligible licensed funds and portfolio companies may receive low- or no-cost cybersecurity offerings to better safeguard vital technologies. Additionally, Cooperative Research and Development Agreements (CRADAs) provide a framework for collaboration between licensed funds and DoD entities. These agreements facilitate research and development activities and enable information sharing, strengthening the ties between the funds, their portfolio companies, and DoD organizations. Further enhancing these efforts, the Office of Strategic Capital (OSC) is planning to introduce the Global Critical Technology Scout program. This program aims to collaborate with nonprofit organizations to identify and expand critical technologies from emerging international companies, enhancing the strategic technological landscape for the United States.
According to U.S. Senate committee on Appropriations, the Office of Strategic Capital is provided with budget authority for over $900 million in loans to promising companies that can scale to further support the defense industrial base for FY24. The bill includes strong safeguards to ensure that loans and loan guarantees are only provided to companies with a strong financial track record, protecting the interest of the taxpayer.
In conclusion, the Office of Strategic Capital (OSC) represents a strategic initiative by the U.S. Department of Defense to attract and scale private capital investments in critical technologies essential for national security. By leveraging programs like the Small Business Investment Company (SBIC) and the newly launched SBIC Critical Technology (SBICCT) Initiative, OSC bridges funding gaps that hinder the growth of early-stage and expansion-phase companies. This multifaceted approach aligns private sector innovation with strategic public investments, bolstering America’s technological edge and economic security on the global stage.
“We must complement the innovative power of the private sector with a modern industrial strategy that makes strategic public investments in America’s workforce, and in strategic sectors and supply chains, especially critical and emerging technologies, such as microelectronics, advanced computing, biotechnologies, clean energy technologies, and advanced telecommunications.” NATIONAL SECURITY STRATEGY
