Venturing forward: Exploring the next phase of govtech investment

For those of us in the government technology market, the last couple of decades have been quite a ride, full of innovation, cash injections from venture capitalists, and a lot of market twists and turns. We've gone from the early 2000s' explosion of early stage startups aiming to drag government operations into the 21st century to the more recent scene dominated by established players and big private equity investments. 

There is a lot of expectation that we’ll continue to see a really active private equity market for govtech, especially related to roll-up and tuck-in deals that respond to the growing need for the government to adopt enterprise rather than point source solutions. However, I believe that conditions are ripe for another explosion of early stage govtech startups in the next few years.

Reason 1: Expansion of Mission Driven Funding

The volume of family offices has grown >10x since 2008 and has served as one of few available capital sources for founders and fund managers in the current market slowdown. Layered on top of that, we’re in the middle of the greatest intergenerational wealth transfer in history so we expect to see even more emerge.

Family offices tend to be more mission driven. Plus new models of venture philanthropy spearheaded by big tech names like Gates, Jobs via Emerson Collective, Zuckerberg, etc have shown how private capital can effectively play a role in major public issues. 

Next-gen family office leadership, whose lives have been shaped by tech innovation, are likely to be focused on the convergence of technology and social issues. Plus more broadly, data from Bank of America says that 75% of Millennials, compared to 21% of older respondents, want to invest in products and ventures that drive environmental, social, and good governance.

That tells me that we’ll see more capital become available for the types of companies that are working with and around challenges the government aims to solve. 

Reason 2: Ripe Landscape for Acquisitions

COVID, ARPA funding, IIJA and recession fears led to a professionalization of public sector arms in many of the big tech companies over the last few years. Think Google, Salesforce, Splunk, Tableau and others. Even with their step into the market in a big way, the government is still a pretty poorly supplied segment. 

Major global and traditional software players and service providers remain the main suppliers of solutions to governments. Yet, they often lack the ability to innovate quickly, have long deployments and don’t necessarily have deep or specialized knowledge and products purpose built for government. 

Even with recent layoffs, especially in the technology sector, we haven’t seen a disproportional disinvestment in these government focused business units. That is because government contracts, while hard to win, are big and sticky, so even when companies will continue to be primarily focused on serving businesses (B2B) they want to stay in the public sector market. This translates to more fertile ground for govtech acquisitions and/or productive channel partnerships with big tech companies that would rather buy (or revenue share) than build to serve the public sector market. 

In addition, many traditional govtech players — Accela, Civica — are coming up on five years post private equity investment. That means their private equity owners are likely  to be thinking about an exit - as a result, leadership will be focusing more on hitting good margin metrics than on growth, which skews the market more towards build than buy.

If you talk to most venture capital funds they will tell you they only want to invest in unicorns — the companies that will return their fund in full. But in reality, they really want the big idea, market changing companies to make up just a portion of their investments — ultimately a big chunk of funding goes to startups that have a clear path to a solid exit. Having a clear path to exit is a great situation for a startup and investors alike, and that exists more now for govtech than it ever has before.

Reason 3: Business Model Innovation

Just to take a step back, the term govtech describes a spectrum of companies - there are companies that sell exclusively to the public sector, companies that have sold their products primarily B2B in the past and have only recently targeted the public sector as a customer in recent years, and finally companies whose direct customer is not the government but whose products nevertheless influence administration and the social issues that government deals is working to solve. 

In recent years, there has been an emergence of the last segment: companies that are not exactly govtech, in that their primary purpose isn’t to develop products that exclusively serve and sell to government, but they are either attacking social good challenges or they are selling products to companies that serve government (B2B2G).

Those companies are likely to align with investor values while also meeting some of the high-growth demands that will continue to be a part of early stage capital funding requirements. There will always be a need for technologies and products purpose built for the government, but as governments modernize their technology stack the delta between business needs and government needs will continue to decrease. That means founders, if you want to work with and serve the government, see if there is a way to have them not be the buyers. That will set you up for quicker growth near term, and expand your total addressable market long term.

The government market is ripe. Government buyers are ready and required to adopt modern solutions, funding is available, and there are proven business models and  compelling paths to exit — thanks to OpenGov's significant investment from Cox Enterprises earlier this year.  For those with a twinkle in their eyes about a way to solve a government problem, now is the time to start building.

Elle Hempen builds companies, products, strategies and partnerships that respond to the most urgent issues of our times. Prior to her current role as EVP for State & Local Strategy at GovExec, she founded and led a government technology company, worked in philanthropy and served in government. Find her on LinkedIn.