When Anduril announced a $910 million drone production facility in Ohio, it was not politics as usual. The main message came from Ohio’s governor, Mike DeWine, while Representative Mike Carey’s press release thanked the governor. Members of Congress usually take substantial credit for defense industrial jobs, but Carey did not because he could not. Anduril sited Arsenal-1 near Columbus partially because of state subsidies.
New defense firms backed by venture financing and state economic development subsidies have given states a political stake in the most innovative portion of federal defense procurement. New entrants promise and sometimes deliver fast, commercial solutions. Subsidies might help bridge from venture funding to sustained Department of Defense contracts, but their political risks include reduced innovation and strategic lock-in on sub-optimal programs.
Political coalitions of Congressmen, statehouses, firms, and workers may protect new entrants politically even if unproven capabilities fail. This could saddle the defense budget with some programs that promised innovation but did not deliver. State politics might thus make the most dynamic part of the defense industry more rigid by introducing the political problems that bedevil some existing programs. This concern runs through state development corporations whose processes are less transparent than congressional appropriations.
Three changes could mitigate these risks. First, Congress should coordinate a state-level marketplace of subsidy bids, and not just for defense. Second, Congress should require public-records disclosures by state development agencies that engage with federal procurement. And third, Congress should implement a version of the Base Realignment and Closure process for defense programs so that facilities and programs protected by state subsidies do not burden the federal budget.
Venture Capital, Defense Allocations and New Business Models
Many new defense firms rely on a different business model from the prime contractors. In the usual process, the executive branch and Congress spread an agreed budget across different programs and select firms to deliver on those programs. Established primes make money from these programs of record, which deliver stable funding over many years. This process also funds preliminary research and development.
By contrast, many new entrants raise money from venture capitalists who bet on these companies’ ability to build a profitable business in the future. The new firms’ offerings do not necessarily derive from federal requests. Instead, they may use venture funding to prototype capability and then offer it to the Department of Defense. This builds capacity ahead of programs of record, and bets that demonstrated prototypes and production will win stable contracts. Venture funding proceeds in rounds, where firms raise capital investments from interested firms to continue building and scaling. Some firms receive limited financing from other transaction agreements so that the Department of Defense can fund promising products.
Venture firms make these investments and expect to profit by constructing a broad portfolio where a few spectacular hits will offset potential failures, of which there are often many. Around 75 percent of venture-backed startups that raise at least $1 million do not return investors’ capital. Roughly 4 percent return 10 times or more the initial investment. Failure is thus an essential part of the venture ecosystem.
This has several consequences for defense firms. Most importantly, few new defense entrants are likely to survive. Moving from prototypes and an initial production run to a program of record is hard. The gap between less consistent funding from other transactions and programs of record is a well-known valley of death where many firms cannot sustain operations.
State Subsidies and the Geography of New Defense Production
Scaling up prototypes into even preliminary production takes significant capital. In addition to rounds of venture financing, state subsidies are another powerful tool for firms that are building ahead of programs of record. Economic development subsidies have a significant role in many industries, and defense is no exception.
New defense firms can draw on state subsidies to either build new capacity or expand existing operations. Anduril’s Arsenal-1 in Columbus is a strong example of building new capacity. Anduril received $830 million in incentives from Ohio, including a $310 million grant, $452 million in tax credits, and roughly $70 million in site and airport financing.
Saronic, a company that builds unmanned and autonomous vessels, likewise took $5 million in grants and additional workforce assistance from Louisiana to expand a shipyard in Franklin. Louisiana Governor Jeff Landry featured prominently in project announcements, just as Governor DeWine did in Ohio. And Regent, which builds an electric sea glider with defense cargo and logistics applications, will receive up to $13 million from Rhode Island if it meets employment targets.
Either way, subsidies support new firms’ business model of building and scaling. While new firms do take federal government contracts, they are using venture capital and now state subsidies as a bridge to the programs of record that power the primes. State economic development funds make scaling defense production less financially risky by funding start-up costs with grants or reducing the long-run costs of facilities via tax abatements. These make firms more likely to recoup their startup costs, and their venture backers more likely to recoup their investments.
While states have long offered subsidies to defense contractors on a commensurately larger scale than new entrants, the primes follow existing programs of record, leading to distinct economics and politics. For most firms like the primes, subsidies do not change where or what they build. Traditionally, many defense dollars follow political considerations, talent clusters, and Congressional allocations, which means the Congressional appropriations process usually determines where new plants go.
Lockheed Martin’s 2017 decision to move F-16 production to Greenville, South Carolina is a good example. Lockheed followed existing facilities in the area, repurposing existing work. There was no real site competition, but former South Carolina Senator Lindsey Graham highlighted his role in foreign military sales, as the F-16 line stayed open through orders from Bahrain and others. South Carolina’s governor had a more peripheral role, enabling $1.5 million in grants for building improvements.
Unlike with the traditional process the primes follow, subsidizing new defense business models transfers some risk to states. Primes build for programs of record with secure federal funding, whereas new entrants have less secure funding. Some new firms could win state subsidies and limited federal contracts because their programs are smaller and less proven. Other transactions or similar agreements can have firms living from contract to contract in the same way they live from funding round to funding round.
When new firms do not deliver what the military needs, states will face a choice between clawing back subsidies or eating the sunk costs. Ohio faced this choice in a different industry with Lordstown Motors in 2023, which went bankrupt despite large state subsidies. For understandable reasons, governments are often reticent or unable to withdraw grants and subsidies. States have also transferred much of their economic development work to privatized entities with weaker disclosure requirements. For example, Texas uses a 501(c)(3) entity, the Texas Economic Development Corporation, to negotiate with minimal financial disclosure before the state agency finalizes deals. These changes increase the risk that state taxpayers fund unsuccessful defense entrants.
Meanwhile, In Washington
As new entrants become increasingly intertwined with state governments, they are also assimilating into Washington. Major new entrants like Anduril, Saronic, Shield AI, and others spend on politics themselves, and attempt to shape key narratives.
But new entrants also benefit from lobbying by their venture funders, whose funding is spread across parties and focuses on key committees. The venture capital firm Andreesen Horowitz advocates for defense acquisition reform and convenes key events such as the Hill and Valley Forum alongside other venture firms. Venture firms are much larger donors and lobbyists than the companies they back, and their political efforts have recently been accused of influencing procurement decisions.
This ecosystem of funders and their lobbying moves influence away from the traditional donation channels and towards political networks. There is not much evidence in open records that new defense firms make significant political donations in states to win subsidies. Political donations are not needed to win subsidies given competition between states and their active economic development bodies.
State subsidies also engage Congress and create incentives for new allocations. New subsidized defense facilities encourage legislators to commit federal funds and thus keep defense jobs in their districts. Congress will often fight hard to keep production and maintenance lines open in their constituencies, even if the services themselves don’t want the system.
The result mixes standard Washington politics, statehouses and venture finance, as state funding positions a firm to draw in more federal money. Jon Husted, Ohio’s Lieutenant Governor at the time of Arsenal-1, moved from state to national politics when he was appointed to fill Vice President J.D. Vance’s vacant Senate seat. Once in the Senate, Husted followed the legislative textbook and highlighted his efforts in helping fund the Collaborative Combat Aircraft, knowing that voters reward such credit-claiming.
The Stakes and Consequences
When new firms use state subsidies to build, they add resilience and diversity to the defense industrial base at the cost of three political problems: political rigidity, state accountability, and taxpayer risk. The fundamental issue behind all of these is that many start-ups will fail and others will produce capabilities that are not useful, as is expected in the venture ecosystem. But instead of allowing those firms to exit, state governments will add political pressure to preserve defense employment.
Giving state governments a significant fiscal stake in new entrants could make the defense industrial base less dynamic. When firms use subsidies as a bridge between ideas and full production, they give state governments and Congress a stake in continued funding, triggering political considerations that make defense programs harder to kill. Such procurement rigidity causes problems that even huge increases in defense spending cannot solve, such as foreign military sales that diverge from national interests. Here, political pressure might add defense spending that does not go to the best capabilities, but to subsidized capabilities.
Second, the rise of state subsidies reduces transparency and introduces new conflicts of interest and defense politics in states. For all their weaknesses, Congressional appropriations committees maintain clear records and exercise oversight of how funds are spent. Privatized state development corporations like JobsOhio are not subject to the same public records requirements. This is less accountable to voters and potentially open to abuse and conflicts of interest. In Ohio, gubernatorial candidate Vivek Ramaswamy has received criticism for venture capital ties to Anduril and potential conflicts of interest with Arsenal-1. In Texas, competition with other states for a new Saronic facility has led to disputes in Cameron County over tax abatements.
Last, these changes expose state and local taxpayers to another cost of providing national defense besides their federal taxes. Governors use subsidies and grants so they can clearly take credit for new facilities and jobs, even if subsidies are not the best policy. In some cases, the local benefits may well offset the costs of grants and forgone tax revenue, but a race to the bottom in subsidies will not necessarily leave the winning state better off. In the case of Arsenal-1, a majority of the promised jobs might not be new employment.
To be clear, new firms are not wrong to take state subsidies when not doing so would put them at a competitive disadvantage. But when new firms have to play the same political games that contributed to problems in the defense industrial base, that could reduce the value they add. Such an outcome would be unfortunate for taxpayers and the defense industrial base.
Three policy changes could help mitigate the genuine trade-off between new firms drawing on subsidies to build capacity and political lock-in. First, the Department of Commerce could organize a marketplace where states make incentive bids for defense firms. Congress could then enforce participation for firms who wish to win substantial federal funds using the Spending Clause. Advocates of interstate compacts on subsidies might support this innovation. This market could and should expand outside defense as well.
Second, Congress should enforce open-records requirements for state private development corporations when firms take federal funds regardless of sector. Interested parties could then better understand negotiations and incentives. This would complement the marketplace, as more transparent state competition would make disclosure less of a competitive disadvantage.
Third, Congress could follow principles from the Base Realignment and Closure Act, allowing an all-or-nothing review of programs that are not adding value, especially when state subsidies are in play. This would be politically difficult and require a different mechanism for private facilities, but the delegation model has worked in the past, as the Base Realignment process led to five rounds of reductions.
The rise of new defense firms has thus reshaped the politics of defense contracting. Bringing the statehouse into the arsenal risks making dynamic new firms politically more like established primes. Those politics could stymie innovation and strain the defense budget at a crucial time.
Joshua Alley is an assistant professor of political science at Baylor University.
**Please note, as a matter of house style, War on the Rocks will not use a different name for the U.S. Department of Defense until and unless the name is changed by statute by the U.S. Congress.
Image: Midjourney
