Sometimes, the most valuable thing to a tech startup is not a pile of cash to lock down coding talent or nab a new office. Sometimes — especially when the company’s main customer is government — the most important thing is finding early customers who can help the startup prove itself.
For about five years, a small spinoff of a private equity firm has been quietly building itself up to do just that: Help companies figure out where to start.
Now, they’re beginning to poke their heads above ground.
The firm, called InState Partners, works on a “sweat equity” model. Instead of putting money into a startup, it offers it access to a network of people embedded in the cultures of governments across virtually every state in the country. The idea is to offer those companies expertise, credibility and a better path to early customers. In return, they take an equity stake like any venture capitalist would.
So far they have three companies in their portfolio: the digital services and payments platform PayIt, the smart highway startup Integrated Roadways and Acivilate, which helps convicts returning to society.
“I think we’ve found an exciting place to be right now where technology is helping provide solutions to government in a way it hasn’t previously to make their lives more efficient,” said Alex Johnson, InState’s president.
The whole concept revolves around embracing all the things that irritate critics of state and local government. If state and local government’s action is glacial, InState wants to take advantage of their slow, unstoppable movement. If state and local government is fragmented, InState wants to find the pieces nobody else is looking at. If state and local government is risk-averse, InState wants to find the ones who need to take on risk.
For example, look at the headquarters of the firm’s first three portfolio companies: two are in Kansas City, Mo., one is in Atlanta.
That’s no accident. Though InState works out of Washington, D.C., it was spun out of Advantage Capital, a St. Louis-anchored private equity firm working specifically with companies in low-income and rural areas. They’re not exclusively middle-America in their approach, but they’re used to looking between the coasts for opportunity.
Rachel Stern, InState’s senior director of client services and the firm’s first formal employee, sees some good reasons for that strategy. For starters, rising living costs in the biggest cities are making it even harder for early companies to get a foothold. They also tend to serve as battlegrounds for competing startups, making it harder to stand out.
She also sees a lot of unnoticed innovation coming out of those areas.
“Often they are in the middle of America, there is a really exciting technology boom happening outside of California and New York and Boston,” Stern said.
Stern and Johnson both come from government affairs backgrounds, and the firm maintains a network of government affairs contacts in most of the states. That means they have the ability to look for governments that are looking to take action on the same problems that InState’s portfolio companies want to solve. They also have the ability to work with legislators who can push governments to solve those problems.
The firm’s focus has traditionally been on state government, but as they’ve waded into their work they’ve found that local government is a crucial piece of the puzzle for gov tech startups.
“I had a governor look me in the eye once and say ‘Alex, governments aren’t in the business of taking on risk, so go prove your company and come back to me, and then we can talk,’” Johnson said.
Local governments, by contrast, are more numerous, more spread out and more fragmented in their approach. Which means there are a lot of localities that might, at any given moment, be ideally positioned to jump into a pilot project on a particular problem.
“Local government is really this petri dish of innovation,” Stern said. “There’s all this opportunity to experiment.”
The approach was valuable to Acivilate, which is fresh off its first fundraising round.
"The first thing it's done for us is it's allowed us to screen out communities that are not working on our issue right now,” said Louise Wasilewski, the company’s chief executive. “One of the challenges of being an early stage company is you've got a big market but you're not sure which places are going to work on it first."
Wasilewski found InState through an Amazon Web Services program that matches AWS’ cloud customers with partners who can help them.
A big problem she was running into was that she was offering basically a new solution — it’s not the kind of thing her customers would put out an RFP for. To investors, that looked like she lacked a clear road to sales.
The partnership with InState gave her company more credibility.
"It gave us a way to answer the concerns of investors around being a company selling to government,” Wasilewski said. “Most VCs will not touch this space, they will not touch government, and in order to convince a VC who had previously said they would not invest to come in, we had to show them that we had a good grasp on how to sell into the market, and that lobbying relationship made a massive difference."