US Government agencies often face a Catch-22 trying to adopt innovative technologies: Procurement rules designed to promote fairness can effectively preclude federal buyers from seeing – or influencing – developments that could eventually help agencies work more effectively.

The Defense Department and intelligence agencies, of course, have been fueling innovative technologies on their own for decades. But as commercial markets have exploded with new ideas, and learned to bring those ideas to market with greater speed, government agencies increasingly find themselves racing to keep up with innovations in the commercial sector.

That’s partly why In-Q-Tel, a non-profit investment arm created by the government’s Intelligence Community more than a decade ago, offers a potential model for how the government might stay better abreast of new technologies.

In-Q-Tel was founded in 1999 to provide the CIA and other intelligence and defense agencies insights into innovative technologies early enough in their development to influence them. In the cold-war era, “government research and development investments were two or three generations ahead of the private sector in their specific interests, such as encryption or analytics. That’s no longer true,” said Kim Taipale, founder and executive director of the Stillwell Center for Advanced Studies in Science and Technology Policy, a research and advisory organization focused on information, technology, and national security policy.

Instead, today’s technology innovators and innovations are found in the private sector, particularly in tiny start-ups. These companies, usually with a handful of employee owners, typically do not contract with the federal government because of the “expensive, extensive, expansive multiple entry-point processes the government demands,” said Felda Hardymon, a professor of management practice at Harvard Business School and a principal at Bessemer Venture Partners, a VC company.

“The CIA can’t just go to the store and buy the technology they need,” said Robert D. Atkinson president of the Information Technology and Innovation Foundation, a non-partisan research and education institute focused on government policies that advance technological innovation and productivity.

“The CIA has specific needs. They can fund the research and development on their own, and they do, but that’s pretty expensive. You end up with siloed markets and technological dead ends. So the idea is ‘what if we find companies doing work similar to what we need and provide them with some funding?’”

Although such thinking might seem obvious, for a government agency in 1999, it was novel. “The CIA foresaw this development [of small companies innovating technology instead of government], which led to the formation of In-Q-Tel,” Taipale said.

“They recognized that a new model must be developed that worked on the commercial level. They came up with In-Q-Tel’s really insightful structural solution. In-Q-Tel’s model is a great one, and it is the way other government organizations should be doing things instead of only through internal development or large contractor-based solutions.”

“In-Q-Tel is not a venture capital firm; we are a strategic investor,” said Lisa Bader vice president of external affairs at In-Q-Tel in a written statement prepared for Breaking Gov. “We are a 501(c)(3), and we follow this strategic investor structure to ensure our focus is helping our customer agencies further their missions.”

In-Q-Tel’s investment portfolio focuses on two primary areas: information and communications plus physical and biological technologies.

D-Wave, a Canadian company specializing in quantum computing, is perhaps typical of In-Q-Tel’s investment approach. It is working on information technology that can make it possible to solve currently unsolvable problems and solve hard problems faster than is possible today.

Sonitus Medical is an example of a physical/biological technology investment. The California company is developing the “SoundBite” hearing system, which is an in-the-mouth technology that transmits sound via the teeth through bone conduction. Though intended as a treatment for hearing loss, its application to the intelligence field is obvious.

In-Q-Tel operates on a fairly small scale. “Their usual investments are between $500,000 and $2 million,” Taipale said. “This is a relatively minor amount for a VC investment, but they and the CIA get a lot of visibility into these innovative companies from their investment.”

Indeed, it’s only by making such investments that In-Q-Tel can get this kind of visibility and influence. Why else would an emerging, innovative company be receptive to the interests of the government intelligence community?

Small or not, In-Q-Tel involvement clearly provides a badge of credibility to companies in which it invests. Out of 37 start-ups in which In-Q-Tel invested from 2003 through 2012, all but one were acquired – the Holy Grail of most start-ups.

“When In-Q-Tel invests in a company, there’s a rigorous vetting process,” said Atkinson. “By designating a company as worthy of In-Q-Tel funding, that company has a much better chance of getting other money. It’s like a Good Housekeeping seal of approval.”

Getting more private investment money obviously benefits companies, but In-Q-Tel helps them – and its intel/defense customers – in another big way, too.

“For emerging growth companies that want entry into the intel/defense community, In-Q-Tel provides advice and introductions,” said Hardymon. “Selling to the federal government is expensive for any company, but for a small company, it’s relatively more so.”

“Working with In-Q-Tel provides our portfolio companies with the time and insight needed to deliver technologies that will address customer needs,” Bader said.

For obvious reasons, that’s as specific as In-Q-Tel gets about how its early-stage investments can directly help its customers. But examples can be found elsewhere as other federal agencies experimented with In-Q-Tel’s model.

Red Planet Capital Partners was founded in 2006 to help NASA achieve insight into new technologies. Although RPCP’s financial plug was pulled about six months after it opened for business, it still has an investment in one company that was made before the money dried up.

“NASA wasn’t in it for the money, but [like In-Q-Tel] to gain visibility into new technology developments in the private sector,” said Graham Burnette a general partner in RPCP as well as in the totally private VC company Sigefi, Burnette and Vallee.

“For example, light-weight battery technology for cellphones could be useful to NASA, too, but it is unlikely that NASA would ever hear about it until the small companies were already selling the batteries to the commercial cellphone industry,” Burnette said. “By then, they wouldn’t be interested in space applications. However, if NASA gets involved early, then the small companies could develop their technology so it would work both for the cellphone industry and for NASA.”

Another In-Q-Tel-like company started by the federal government, OnPoint Technologies, was founded in 2002 to address the needs of the U.S. Army. The Florida-based “venture capital initiative” is healthy and investing in innovative power generation and storage companies. One example of OnPoint Technologies’ portfolio is Missouri-based Akermin, which is developing a portable fuel cell based on proprietary enzyme technology.

Besides its unusual set of customers, In-Q-Tel is different from ordinary VC companies in two other ways.

First, most VC companies are ultimately interested in the financial payoff. “In-Q-Tel is much more interested in the technology itself,” said Paul Taibl, vice president of the Business Executives for National Security, a nonprofit organization of former business executives who use their expertise to advise the national security community. “If the technology also happens to be commercially successful, so much the better.”

Secondly, In-Q-Tel’s board of directors, executives and employees won’t get rich from the company’s investments. In fact, they don’t get a penny. “In-Q-Tel’s charter requires them to put any profits back in their portfolio investments,” Taibl said. “The Senate Appropriations Committee was concerned about wild profits enriching the company, which would reduce government control.”

So In-Q-Tel’s personnel aren’t owners – they are paid much better than government employees because their technology and private sector experts can’t be hired for civil servant salaries, but the company encourages turnover at all levels every two to three years to keep new blood constantly coming in.

In-Q-Tel’s lesson for government agencies is that it doesn’t take huge investments in single companies like the ill-fated Solyndra to find and employ new technology and innovation.

“In-Q-Tel provides a very successful model,” Taipale said. “To find out what is really going on in technology innovation, write $500,000 checks, not $500 million ones. In-Q-Tel best marries government responsibility with commercial risk-taking to give the government visibility into what’s developing, to see where technology is going. This model could be applied to education, health and energy as well. The problem for government is to get early access to technology that can help make it more efficient. Government can do this with innovative approaches like In-Q-Tel.”

In-Q-Tel’s Current Portfolio of Technology

10gen
3VR
Adaptive Computing
Adapx
Advanced Photonix, Inc.
Alfalight
Basis Technology
Bay Microsystems
Biomatrica
Boreal Genomics
Cambrios
Carnegie Speech
Claremont BioSolutions
Cleversafe
Cloudant
Cloudera
Connectify
Contour Energy Systems
D-Wave Systems
Digital Reasoning Systems
Digital Solid State Propulsion (DSSP)
Elemental Technologies
Etherstack
FireEye
Fluidigm
FMS Advanced Systems Group
Genia Photonics
GainSpan
GATR Technologies
Huddle
ikeGPS
iMove
Imprint Energy
Infinite Power Solutions
Infinite Z
InnoCentive
IntegenX
InView Technology Corporation
KZO Innovations
LensVector
Lime Microsystems
Lingotek
LucidWorks
MedShape
Mersive

MiserWare
Mocana
MotionDSP
Nanosys NetBase
Nextreme Thermal Solutions
NovoDynamics
Oculis Labs
OpGen
OpenSpan
Palantir
Pelican Imaging
Pixim
piXlogic
Platfora
Power Assure
QD Vision
Quantum4D
Quanterix
Qynergy
Recorded Future
RedSeal Networks
ReversingLabs
Semprius
Seventh Sense Biosystems
Signal Innovations Group (SIG)
SiOnyx
SitScape
Silver Tail Systems
SkyBuilt Power
Sonitus Medical
SpectraFluidics
SpotterRF
StreamBase Systems
T2 Biosystems
Tendril
Teradici
TerraGo Technologies
ThreatMetrix
Traction Software
Veracode
Visible Technologies
VSee
Walleye Technologies
WiSpry