From batteries to semiconductors to quantum tech, the United States and the People’s Republic of China have been locked in a race to finance and deploy foundation technologies, which has intensified in the past ten years. In pursuit of manufacturing dominance in strategic sectors, China has built the world’s largest state capital apparatus. Meanwhile, America leads in developing laboratory prototypes and discovering breakthrough innovations. Winning this race would underwrite economic leadership and ensure national security for the United States for decades.
For the last three years, the Institute for Security and Technology’s Strategic Balancing Initiative (SBI) has worked to accelerate the American competitive advantage by problem-solving public-private misalignments in the technology development ecosystem. Last fall, IST Adjunct Senior Fellow Pavneet Singh and Distinguished Senior Fellow Michael Brown authored an SBI report exploring how the United States might realize disruptive national capabilities, and calling for harnessing the power of the venture capital industry to unlock innovation. Today’s report builds on this work.
“The Missing Middle: How to Close America’s Deep-Tech Financing Gap in Strategic Competition with China” explores deep-tech financing in the United States and China and identifies four targeted mechanisms to close America’s missing middle gap without replicating Chinese dysfunction.
To learn more, IST’s Lillian Ilsley-Greene sat down with author IST Associate for Ecosystem Trust & Safety Fatima Faisal Khan.
Today’s report builds on prior analysis from IST Adjuncts Michael Brown and Pavneet Singh, Why Venture Capital is Indispensable for U.S. Industrial Strategy. Can you summarize that work for us? How did it inform your research?
“In their report, Michael and Pavneet make the case that venture capital stands out as the “principal engine for commercializing promising new technologies.” They explore how to align American national technology priorities with venture capital incentives across the full innovation pipeline–from Seed funding to Series B and beyond.
Now, in this latest report, we focus specifically on the systematic financing gap at the missing middle stage—where hardware-intensive technologies transition from prototype to commercial manufacturing. Our research zeroes in on the $50-$300 million financing gap where laboratory prototypes must become manufacturable products, which is also the exact stage where American companies repeatedly lose to Chinese competitors despite technological superiority.
Their framework helped us understand venture capital’s structural role in the innovation ecosystem, and subsequently informed our analysis of why even the most sophisticated deep-tech venture firms encounter limits. We found that these limits stem not from lack of expertise or risk tolerance, but from fundamental mismatches between fund structures and hardware manufacturing requirements.”
How did you conduct your research on venture capital investment in deep tech in the United States? How did your analysis process on deep-tech financing in China differ?
As part of our research process, we conducted in-depth interviews with 10 leading venture capital firms actively investing in deep tech hardware, including advanced manufacturing, batteries, semiconductors, and advanced materials. Those interviews revealed that the binding constraint operates precisely at the demonstration and pilot production stage, which is when companies must construct their first commercial-scale facility. In our conversations, investors consistently described companies that could raise capital to prove their science works but that struggled to raise the capital needed to build first-of-a-kind commercial facilities. As one investor explained it to us:
"A software company raising $2-5 million in Series A with revenue traction is an attractive investment story, but a deep-tech company seeking $50 million for a first-of-a-kind facility without revenue is a fundamentally different risk profile that most venture firms cannot accommodate."
“When it came to exploring venture capital in China, our analysis differed significantly. We faced limited transparency and blurred boundaries between private investment and state coordination, requiring us to triangulate three primary sources: peer-reviewed academic research with access to Chinese-language policy documents; reporting by specialized outlets covering Chinese technology policy; and interviews with experts on Chinese venture capital ecosystems, including investors who operated funds in China and policy analysts tracking industrial policy.”
You talk about this “missing middle” for American companies. Can you give us an example of that gap?
“The story of San Jose-based battery manufacturing company QuantumScape perfectly illustrates this gap. The solid-state battery company spent a decade proving their science worked, and venture capital handled that stage just fine. But when they finally had working prototypes and needed to build actual manufacturing facilities, they hit a wall. The timeline and capital requirements for building first-of-a-kind production lines simply don’t fit into standard venture fund structures.
Years after founding, they’d raised enormous sums but still hadn’t shipped commercial products because the problem wasn’t their technology—it was the financing architecture. They eventually got lucky with a special purpose acquisition company (SPAC) merger that provided the capital they desperately needed, but that window quickly closed, leaving dozens of other deep-tech companies stranded at exactly the same stage: technology validated, but no clear path to prove they could manufacture at scale.
Meanwhile, Chinese competitors with similar or even inferior technology access patient capital from policy banks in months and reach commercial production much faster, establishing market position before American innovation ever scales. Our report documents this pattern across sectors: companies excel at raising early-stage capital and can access late-stage financing once operations are established, but face a systematic gap at the critical transition stage where they need substantial capital to build first commercial facilities.”
In comparing funding structures in the United States and China, you found that venture capital can generate breakthrough technologies in a way that state direction cannot replicate. What mechanisms can we take from China’s approach?
“While China’s state-directed model suffers from serious dysfunction, they’ve solved specific pieces of the puzzle that we should learn from, not through replication but through smarter design. China’s policy banks demonstrate that patient, long-term capital at below-market rates creates compounding advantages in hardware sectors, and their integrated approach shows that coordinated deployment across the commercialization pathway delivers results when done right. We put forward four specific mechanisms that America can derive from this approach:
- Loan guarantees that enable 15-year financing at sub-3% rates
- Statutory speed requirements with six-month approval deadlines
- Demand-side coordination through $20-30 billion in advanced purchase commitments
- Targeted technology maturity demonstration grants (proving readiness at critical inflection points to unlock private capital).
Above all, this research highlights that the United States can in fact achieve superior integration through partnership, by letting venture capital identify winners while public capital provides specific enablers. In contrast, China’s approach of state control attracts second-tier talent, lacks novel innovation and creates political paralysis—problems that the partnership model can successfully avoid.”
What can we expect for the future of America’s strategic competition with China?
“The competitive landscape is bifurcating in ways that play to each system’s structural advantages and expose its weaknesses. China’s manufacturing-focused model will continue winning in domains where technologies are mature and success depends on execution and scale; they’ll likely maintain dominance in batteries, solar panels, and established semiconductor nodes because their policy banks can deploy patient capital faster and cheaper than American companies can access through fragmented financing. But America’s innovation-focused model maintains clear leadership where breakthrough discovery matters—AI, advanced software, quantum computing fundamentals, and biotechnology—because venture capital generates technologies that state direction simply cannot replicate.
The decisive question for the next decade is whether America can close the missing middle gap to translate our innovation advantages into manufacturing leadership, or whether we’ll continue the pattern where U.S. taxpayer-funded research creates breakthrough technologies that Chinese integrated capital then captures at the manufacturing stage. If the United States is successfully able to implement the four mechanisms outlined in our report, we believe that they can prove that partnership mechanisms delivering coordination without centralization outcompete China’s state-directed model. But without these changes, we should expect Chinese companies to continue establishing price points and capturing market share in strategic hardware sectors, even when American companies pioneer the underlying science and engineering.”
