In the wake of the September 11 terror attacks that prompted increases in US military spending, defence is seen as the latest growth industry by VCs. Although much of the military spending will go to traditional defence contractors such as Boeing and Raytheon, some smaller companies with innovative technologies are also seeing opportunities.

"I'm having a lot of companies come to me and ask, 'Can you help us do business with the government?'" said Christopher Michel, chief executive of Military Advantage, a venture-backed company that operates the Military.com website. "They see defence as a growth sector."

While many VCs and start-ups are eager to do business with the Pentagon, they face numerous hurdles. The defence establishment's plodding business culture differs starkly from the informal dealmaking that characterises VCs and tech start-ups.

"In Silicon Valley, a handshake means a lot," Mr Michel said. "In the government, contracts mean a lot."

Also, officials who allocate and spend defence dollars may not be excited by all the latest information technology, typically the main focus of venture investing. To meet the Defense Department's traditional needs, some venture firms have have put their money into the companies that make more old-fashioned war equipment, such as tanks.

The Carlyle Group, which includes former Defense Secretary Frank Carlucci as an officer, took a big pre-initial public offering stake in United Defense Industries, which makes armoured vehicles, naval guns and missile launchers. United Defense most recently received a Dollars 58.4m contract for 27 M88A2 Hercules recovery vehicles for the US military and in February it landed a Dollars 1.8bn contract to further develop the next-generation self-propelled Crusader, a 155 mm artillery system. The Army plans to spend Dollars 11.1bn to develop, buy and support 480 Crusaders.

Some venture capitalists, anticipating a bumpy road ahead for technology start-ups seeking Pentagon dollars, are urging the Defense Department to follow the lead of the Central Intelligence Agency, which has its own venture firm.

In-Q-Tel was started by the CIA in the late 1990s after the agency concluded it needed private industry to track technology trends, especially those in information technology.

"It's basically about finding the needle in the haystack, and knowing what haystacks are out there," said Gilman Louie, In-Q-Tel's chief executive. "There has got to be a better way than government contracts."

Since its launch, In-Q-Tel has invested in about 20 companies after screening 2,000 funding requests, Mr Louie said, noting the CIA was "smart enough to say they couldn't do it within their system".

The CIA seems especially interested in companies that address its own shortcomings. In-Q-Tel helped fund Tacit Knowledge Systems, a company that makes software that links workers who share mutual interests, skills and knowledge.

Tacit says its "expertise automation" software helps overcome compartmentalisation within organisations. The goal is to offset the constant criticism of the CIA that critical information does not flow smoothly within the agency.

"They have the same problem as any big company of being self-aware at a granular level," said David Gilmour, Tacit's president.

Tacit also is trying to sell into the Pentagon and has had a warm welcome, said Elisa Cafferky, Tacit's manager for federal relations. "An intelligence analyst gets it right away because they're in compartmented, secure environments, working in their little vaults and don't know who to call for help," Cafferky said.

Investments like Tacit are a positive sign to Jim Opfer, a former US Air Force colonel and network architect for the National Reconnaissance Office who now heads the Silicon Valley venture firm LaunchPower.

But Opfer would prefer to see the Pentagon, like In-Q-Tel, tap technology start-ups rather than wait for them to come knocking. However, he would add a twist: while the CIA funds In-Q-Tel, a not-for- profit firm, Opfer wants the Pentagon to hire a for-profit VC firm to run its portfolio and assume risks and rewards as an investor.

Opfer also suggests that military officers serve tours of duty with such a firm to build technology industry contacts, especially in Silicon Valley. "People in the Pentagon don't know what is going on in Silicon Valley," Opfer said, adding that technology start-ups also "need to get inside the Pentagon's thought process".

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