Key Takeaways
- The Department of Defense (DoD) is intensifying efforts to broaden its supplier base by engaging startups and early-stage companies that can deliver critical emerging technologies. New structures and incentives aim to connect commercial innovation and private capital directly to defense needs.
- While large prime contractors remain indispensable, a new “hybrid” procurement model is emerging – one that integrates venture-backed and dual-use technologies into defense acquisition.
- For small and emerging companies, success in this environment hinges on early identification and careful navigation of legal, regulatory and compliance issues.
- These reforms aim to reduce bottlenecks, accelerate innovation cycles and open the door to emerging technology companies – a challenge that BakerHostetler’s Mission Bridge™ initiative was built to address.
Introduction
Recent statements from Secretary of Defense Pete Hegseth and senior acquisition officials underscore that U.S. defense competitiveness depends on harnessing commercial innovation in fields such as artificial intelligence, autonomy, quantum technologies and advanced manufacturing.
Public-private partnerships have been central to Hegseth’s modernization agenda since his confirmation hearings. The 2025 National Defense Strategy and accompanying acquisition reforms now embed this approach into policy and practice.
DoD’s objective is not to replace the traditional primes but to unclog supply-chain bottlenecks, accelerate innovation cycles and expand participation by high-growth technology companies – lowering long-standing barriers to entry for startups and early-stage innovators.
Institutional Changes: Turning Policy into Practice
Although DoD has long expressed an interest in engaging these types of nontraditional contractors, this time DoD appears to be backing its rhetoric with tangible institutional reforms, already visible in data, budgets and industry behavior:
- Expansion of the Defense Innovation Unit (DIU): The DIU continues to bridge commercial technology and military applications with projects spanning autonomy, energy resilience, digital infrastructure and human performance systems. It now functions as a core acquisition channel reporting directly to the secretary of defense. The FY2025 budget request allocates record funding for rapid prototyping, experimentation and innovation-to-production transitions.
- New Capital Pathways via the Office of Strategic Capital (OSC): Through loan guarantees and co-investment mechanisms, the OSC aims to draw venture and private equity investment into technologies deemed essential to the defense supply chain – from microelectronics to advanced materials.
- Alternative Contracting Mechanisms: DoD components are increasingly using Other Transaction Authorities (OTAs) and Commercial Solutions Openings (CSOs) – vehicles that offer speed and flexibility to nontraditional contractors. These pathways allow startups to prototype and scale technologies without navigating the full complexity of the Federal Acquisition Regulation (FAR). OTA and CSO usage has now surpassed $17 billion annually, up from less than $5 billion just five years ago.
- Bridging the “Valley of Death”: Programs such as Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) are being reauthorized and refined to help successful prototypes transition into full-scale production contracts, addressing the chronic funding gap between research success and acquisition.
While major primes remain central to the defense industrial base, DoD has started incentivizing collaboration between primes and smaller, nontraditional firms. Many primes have launched venture arms or accelerator partnerships to maintain visibility into startup ecosystems. Together, these trends are shaping a hybrid defense marketplace – one in which established contractors integrate technologies developed by smaller, faster-moving innovators.
Legal and Regulatory Considerations in a Hybrid Marketplace
As the defense innovation ecosystem broadens, both startups and traditional contractors must navigate a complex set of compliance challenges:
- Nontraditional Contractor Status: Startups with limited defense experience may qualify as nontraditional defense contractors and thus receive added flexibility under OTAs and similar vehicles. Establishing and documenting this status early can significantly influence eligibility and compliance requirements.
- Intellectual Property and Data Rights: Government license rights vary by funding source and contract type. Companies should, where possible, separate the commercial and defense versions of their technology. Startups should take steps to segregate their core IP and negotiate for limited or government-purpose rights for government-funded research and development, preserving their core IP while granting the government only defined usage rights. Primes, meanwhile, must ensure that subcontract IP provisions align with program requirements.
- Export Controls and CFIUS: Foreign investment or collaboration can trigger scrutiny under ITAR, EAR and CFIUS. Early risk assessment and mitigation planning are vital, particularly for venture-backed firms with foreign capital participation.
- Cybersecurity and Supply Chain Integrity: All DoD contractors face expanding obligations under NIST SP 800-171, Cybersecurity Maturity Model Certification (CMMC), and related cybersecurity frameworks. Noncompliance can result in ineligibility or exposure under the False Claims Act. Implementing robust controls early positions a company to scale securely within the defense sector.
- Subcontracting and Flow-Down Clauses: Even under flexible contracting models, many FAR and Defense Federal Acquisition Regulation Supplement (DFARS) provisions flow down to subcontractors, including rules on domestic sourcing, ethics, cybersecurity and small-business participation. Mapping applicable flow-downs at the outset of teaming agreements helps avoid downstream compliance conflicts.
What’s Next?
The Pentagon is evolving toward a more agile, commercially connected defense ecosystem. Its success will depend on whether procurement reforms make participation sustainable for startups – and whether those startups can scale responsibly while meeting defense standards.
Opportunities across the innovation spectrum are substantial, but so are the compliance expectations. Companies that understand both the policy intent and the regulatory framework will be best positioned to thrive as the DoD redefines how it buys, builds and deploys technology.
BakerHostetler’s Mission Bridge helps early-stage defense and dual-use technology companies take advantage of this shift toward an agile, hybrid defense market. The program combines strategic legal experience in venture formation and funding; DoD contracting; IP licensing; export controls; CFIUS and foreign ownership, control and influence (FOCI); and tariff mitigation to help emerging companies connect innovation to opportunity. Contact us for a confidential consultation.