CIA Forms VC Unit –

WASHINGTON, D.C. – It is difficult to read the words “Central Intelligence Agency” and “venture capital” in the same sentence without expecting a punch line.

But it’s no joke. The spy agency has carved $28 million out of its 1999 budget to set up a venture group operating as a separate non-profit entity. The organization, called In-Q-It, will be funded annually from the CIA’s budget said Jody Westby, chief administrative officer and counsel to In-Q-It.

The “In” from its title stems from intelligence, the “Q” is a nod to the James Bond character who invents spy gadgets, and the “It” is a reference to information technology, Westby explained.

In-Q-It’s goal is not to fund the development of spy gadgets but to tackle the more mundane problems that the CIA shares with big businesses such as the need for information-management tools and concerns about Internet privacy and security. The venture group will look for technologies that can be commercialized and hopes to serve as a kind of venture capital-incubator/solutions broker combination, Westby said.

In-Q-It would not fund, for example, the development of a camera that could fit on the head of a pin, said Westby.

Westby does not have security clearance and nor does anyone working at In-Q-It, and the group’s work will be unclassified, she noted.

The CIA opted to create a venture group to tap Silicon Valley’s best minds – and to obtain solutions to its problems more flexibly and quickly than regular government contracting and procurement processes allow.

In-Q-It was incorporated in February, and it set up headquarters in Washington, D.C. The group was slated to open a second office on Menlo Park, Calif.’s Sand Hill Road, the heart of venture capital territory.

The group’s president and chief executive is Gilman Louie, who came from toy seller Hasbro’s on-line business group. Christopher Tucker, who came to the organization from Columbia University where he was senior adviser to the executive provost, is In-Q-It’s senior strategist and director of technology assessment and mapping.

In-Q-It still is looking for a chief technology officer and a corporate security director, while Louie plans to hire research analysts and technology analysts, as well as possibly some VC-oriented staffers, Westby said.

She did not know how much In-Q-It would invest per company, but for now, the group will stick solely to United States investment opportunities.

She emphasized that while the venture group is funded by the CIA and its mission is solving the agency’s problems, it is not a part of the CIA. “We operate just like any other private sector company. We are wholly independent,” she said, noting that Louie was hired to lead the venture without ever meeting with the CIA.

Like many corporate venture groups, In-Q-It has a strong strategic bent to its work. In fact, returns are not a real concern, although the group would like to recoup money to help fund future investments, Westby said. “We’re not in the money-making business; we’re in the solution-producing business.”

In-Q-It has no management fee or carried interest split; managers are paid a salary from the CIA’s budgetary allocation for In-Q-It. Westby acknowledged, however, that the pay structure could cause turnover in the group’s ranks as those who learn enough leave In-Q-It for higher-paying private sector VC jobs. On one hand, such turnover will let In-Q-It bring in fresh blood and new energy, while allowing the group to send forth talent into the marketplace.

Salary is not all that important to Westby, who joined In-Q-It from the Progress and Freedom Foundation think tank and previously worked for the United States Chamber of Commerce. “There is a very strong patriotic element to why we’re doing this, too,” she noted. “Money is not the driver. It is the opportunity to participate in this company and in this exciting new business model that is worth a lot to me, personally, and those rewards you just can’t measure.”

Bay Area venture capitalists had mixed reactions to the new CIA-funded firm, ranging from humor to skepticism.

Upon hearing the news, Redwood City, Calif. Internet-oriented group Draper Fisher Jurvetson publicly released a humorous letter the firm sent to the CIA with a advice about how adjust to Silicon Valley.

“Hits are what we call visits to Web sites, not what you know them as,” the letter said. “Collecting eyeballs is not to be taken literally.”

Communications Ventures Partner Roland Van der Meer was not enthusiastic about In-Q-It, saying the government should be investing in the private sector. Further, he could not think of a VC firm that would need or want In-Q-It in a deal. The organization’s CIA ties could make venture-backed companies nervous about dealing with international markets, he added.

“What we bring to the table is some seed funding, and we bring a ready market, a ready customer. That is the CIA, and, hopefully, there would be interest from other government entities as well,” Westby said of her group’s attractiveness to entrepreneurs and potential co-investors.

But Technology Crossover Ventures General Partner Jay Hoag was not convinced. “Very few technology companies have found the government a thriving, profitable place to be,” he said. In the 65 deals his firm has completed, most of which have been Internet related, he could not think of a single occasion in which the boards of any of those companies wanted to pursue a strategic deal with the government, he said.

Van der Meer, however, did see a way In-Q-It could be helpful: by serving essentially as a granting agency, giving researchers funding to do research and development on their projects. Venture capitalists cannot afford to be such long-term investors; they can’t wait several years on R&D efforts. But without a concern about returns, the CIA-backed fund could serve that need.

Under such a scenario, Communications Ventures might be interested in backing a more developed venture that had In-Q-It’s help previously.