National Security Starts with Small Businesses
Small Businesses Must Remain a Focal Point of National Security
By: Michael Birmingham
Small businesses comprise an essential component of American economic growth and national employment. According to the Office of Advocacy at the Small Business Administration, as of May 21, 2020, small businesses represent 99.9% of all businesses in the United States. America’s 31.7 million small businesses employ 60.6 million people, or 47.1% of the American workforce. Said another way, almost one in every two individuals is employed by a small business.
Small businesses are active in the government and public sector. The government awarded a record setting $120.8 billion in prime contracts to small businesses in CY2018. This figure only increases when considering small businesses that serve as a sub-contractor. In total, an estimated 150,000 small businesses are a part of the defense industrial base and some occupy key positions in a long supply chain of mission critical projects.
Removing a vital product or service from any part of the defense supply chain has the potential to create a ripple of negative impacts. For example, a small business serving as a sole source supplier of parts for the Navy’s F-35 Fighter Jet program may be five or six steps removed from final delivery. Even a disruption that far down in the supply chain has the potential to cause significant delays and, more importantly, the military’s ability to fulfill its mission.
The COVID-19 pandemic has already had a significant and troubling impact on America’s small businesses. The SBA Office of Advocacy calculated that, between the months of March and April, companies with less than 500 employees dropped -17.8% of their workforce, whereas companies with over 500 employees shed -13.6% of their employees. The hardest-hit companies employ 20 to 49 employees and decreased their respective workforces by a staggering -21.5%. These figures are indicative of distress and have amplified national security risks related to inflows of adversarial capital across the defense supply chain.
To weather poor current economic conditions, small businesses experiencing liquidity issues are most likely turning to the capital markets for short and long-term financing solutions. In doing so, small businesses will attract investments from adversaries looking to infiltrate the defense industrial base. The potential of adversarial investment from foreign actors poses risks to the defense industrial base, the broader private sector and could even lead to an increased likelihood of intellectual property theft.
“Small businesses with government customers need to look down the road at potential defense spending reductions in outyear budgets stemming from Covid-19 costs, and be ready to weather the storm with operational expertise to pivot their organizational strategy,” said DCG Partner Reynold Hoover, LTG (Ret.), adding that “budget reductions will put greater pressure on small businesses to sustain operations and highlight their need to access the capital markets.”
Department of Defense and Congressional leaders recognize the risks posed by adversarial capital and have recently attempted to mitigate these risks by enacting new policy, reviewing long-term strategy for continued defense innovation, and creating new initiatives such as the trusted capital marketplace. These changes are geared, in large part, towards limiting foreign influence over American businesses engaged with government customers.
Lastly as distressed small businesses navigate the COVID-19 pandemic, founders and management teams can lead by continuously evaluating their exposure to foreign investment and reviewing mechanisms in place to source suitable financing. In addition, diversified primes should continue to monitor their supply chain for vulnerabilities and look to team with organizations that have addressed financing risks. These small but meaningful efforts can work to build a sustainable defense industrial base over the long-term and strengthen the entire private sector.
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Michael Birmingham is an Associate at Donovan Capital Group (“DCG”), an investment firm that makes non-control structured equity and mezzanine debt investments in profitable, lower middle-market companies that work with (or desire to work with) the U.S. Department of Defense or Intelligence Community. DCG is a designated Trusted Capital Partner of the Department of Defense.
For more information, please visit www.donovan-capital.com or email: info@donovan-capital.com.
