Investing at the Edge: Venture Capital and the Future of Defence Innovation

The Surge in Defence Capital

For the first time in a generation, European defence technology has become investable. The sector, once seen by mainstream public and private capital as often politically complex or reputationally risky to invest in, is now central to the conversation about resilience, sovereignty, and technological leadership. Since 2022, Venture Capital (VC) has flowed into the defence and national security ecosystem at a rate not seen since the Cold War’s final decade. 

While the second Russian invasion of Ukraine has brought sharp focus on to the sector, this is only the most recent part of a longer-term trend.  Great Power Competition, which has been evolving rapidly over the last decade is driving this enduring shift. It reflects a structural reappraisal of defence as an engine of technological renewal and economic growth, driving innovation in new and novel areas such as AI, sensing, and quantum systems. Yet beneath this boom lies a fundamental question: can VC, born from the need to finance emerging technology such as the semi-conductors of the early computers, and more recently to fund short-cycle software growth by virtue of the low barriers to entry, adapt to a domain defined by secrecy, regulation, and sovereign demand?

Mapping the Terrain: Where Capital Is Flowing

Most VC in defence has followed a predictable path. Funds and investors have clustered around dual-use technologies such as autonomy, AI-enabled decision systems, simulation, and sensing. These areas are particularly attractive as they often combine the tangible, deep-tech innovation historically funded by venture capital with the scalable, software-led, and data-intensive characteristics that have come to dominate modern investment theses. While venture capital has a rich history of backing hardware and complex engineering, the sector has more recently gravitated towards software businesses due to their lower barriers to entry and rapid scalability. Dual-use defence technologies, therefore, offer a compelling proposition: they can leverage the familiar growth dynamics of software while addressing critical, real-world challenges. Additionally, they enable many investors who are uncomfortable with pure defence to stay within their comfort zone, technically or reputationally.

In the United States, scaleups like Anduril, Shield AI, SpaceX, and Palantir have powerfully demonstrated the efficacy of vertically integrated platforms, initially focused on defence but now adeptly bridging the civil–military divide. Europe, however, presents a stark contrast, characterised by a fragmented ecosystem and a pronounced aversion to direct defence investment. While this landscape remains challenging, a new generation of defence tech companies, such as Tekever, Quantum Systems, and Helsing, are beginning to emerge, demonstrating significant potential for innovation and challenging traditional paradigms. Yet, this deep-seated reluctance towards pure defence, a sector that has proven foundational for many leading US technology companies, has historically resulted in suppressed valuations and constrained exit pathways. Although initiatives such as NATO’s Defence Innovation Accelerator for the North Atlantic (DIANA) are beginning to stimulate activity, the majority of deal flow remains small, nationally siloed, and concentrated on low-risk technologies that offer early proof-of-concept but lack significant operational leverage. As a result, many opportunities struggle to meet the viability criteria for venture capital backing.

The problem is not the quantum of capital but its concentration. Drones, Intelligence Surveillance Reconnaissance (ISR) platforms, and command-and-control software absorb disproportionate attention, while less glamorous but strategically vital domains e.g., energetics, electronic warfare, advanced materials, logistics, and propulsion, remain neglected. VC, in chasing familiarity, risks reinforcing the very brittleness defence innovation is meant to solve.

UK MOD © Crown copyright 2025

Has the Boom Peaked?

Despite cooling since mid-2024, the current wave of defence investment is far from over. Rather, it is beginning to mature. The initial post-Ukraine rush inflated valuations and generated a predictable herd effect, as generalist funds sought to signal patriotic and contemporary alignment, but without taking significant risk and most lacking any hands-on experience in defence and national security.

Now, with tighter capital markets, rising interest rates, and delayed procurement cycles, some of that exuberance is fading. Limited Partners are starting to ask harder questions: what is the time to revenue in a regulated market? What are the credible exit pathways when Initial Public Offerings are scarce and primes are selective?

Yet the underlying drivers including geopolitical instability, rearmament cycles, and the digitalisation of warfare, remain intact. The next phase will favour funds with genuine domain expertise to enable an innovative approach that gets to the heart of these operational problems, established military and government relationships, and the patience to operate across multi-year procurement timelines. They would also benefit from having the influence and credibility to go outside the usual processes seeking agility and efficiency in the procurement function. The hype cycle is coming to its peak; but significant alpha remains for disciplined, experienced investors.

The VC Model Under Stress

Defence exposes modern European VC’s structural weaknesses. The classic European VC model has focused on investments which are low risk, have limited capex requirements, and offer early revenue opportunities, but this does not align with the needs and character of a sovereign, regulated market.

Many new entrants have imported playbooks from commercial tech and discovered, too late, that defence innovation cannot be blitz-scaled. Procurement cycles can be opaque, customer requirements evolve with geopolitical shifts, and sales depend on credibility as well as capability.

The resulting failures often fall into three categories. First, as has been mentioned previously, lack of defence knowledge: many investors underestimate the complexity of the procurement process and the realities of the military customer not well versed in the needs and motivators of business. Second, lack of financial and technical discipline: mission driven founders sometimes ignore capital intensity and cashflow risk and often lack the sophistication to derisk their investments or funds as a financial product that generates limited partner returns. Third, market misunderstanding: defence is a monopsony, i.e., the buyer is the state, and its incentives are strategic, not commercial. In short, the funds which will succeed combine defence subject matter expertise, technical backgrounds, and the required sophistication in financial management. The future model must therefore create a hybrid: part venture, part infrastructure, part policy.

Bottlenecks and Capital Gaps

In Europe, while innovation remains a challenge the greater challenge is scaling. Early-stage capital is continuing to grow national accelerators, NATO’s DIANA network, and seed-stage public–private funds have created a lively pre-Series A ecosystem. However, the pathway from prototype to production, typically requiring Series B or later financing, remains somewhat barren.

Institutional investors remain cautious: Environmental Social Governance (ESG) frameworks still penalise defence exposure, regulatory fragmentation limits cross-border aggregation, a lack of understanding of the pan-European defence sector, and narrower liquidity options. Even where growth-stage capital exists, the absence of predictable procurement contracts or export licences can deter deployment.

This creates a ‘valley of death’ in which promising firms stall between demonstration and adoption. Targeted policy instruments such as long-term offtake agreements, sovereign loan guarantees, or pooled capability funds are critical to support the maturation of the European defence startup economy. Without these, the European landscape risks remaining a collection of clever prototypes without production scale, while the best in class leave for more attractive investors and markets such as the United States or the Middle East.

Government as Market-Maker or Market disruptor?

Governments now face a strategic choice: Either act as catalysts of private capital or continue to set the conditions that constrains it. On the positive side, public co-investment and accelerator models have normalised the idea of early-stage defence entrepreneurship. Initiatives such as the UK’s Defence and Security Accelerator (DASA), France’s Agence de l’innovation de défense (AID), and NATO’s innovation grants somewhat signal intent to modernise.

Yet fragmentation remains endemic with programs being often small, overlapping, and poorly sequenced. A startup can easily spend more time navigating grant paperwork than developing capability. This leads to innovation rhetoric outpacing procurement reform; pilots rarely become contracts. Further, these all lack clear, predicable transition pathways. Without these, startups become reliant on grant funding, resulting in taxpayer funded science projects, instead of venture-backed scale ups.

Most critically, governments seldom articulate a coherent capability roadmap; it is always suggested that the next document will solve the current challenges, yet what arrives often does not do what was wanted or what was needed and this is especially true in Europe. Without clarity on where the state seeks to build sovereign capacity, whether in space ISR, energy resilience, or munitions production, private capital is forced to guess. That guesswork drives herding into popular domains, leaving core capabilities underfunded.

Strategic signalling that articulates very specific direction to operational propositions is therefore an essential missing ingredient. Governments must not only ‘crowd in’ capital, but guide it, defining demand in operational terms investors can trust.

UK MOD © Crown copyright 2025

Exits and the Role of Primes

For venture investors, exits define viability, but in defence, traditional routes to liquidity such as IPOs are rare. The most common path is strategic acquisition by a prime contractor or sponsor acquisition into or as the anchor of a rollup strategy. 

Recent examples illustrate the trend: BAE’s purchase of Malloy Aeronautics, Rheinmetall’s investments in autonomy and robotics, Anduril’s serial acquisitions of smaller sensor and drone firms, and Helsing’s private equity style acquisition of over half a dozen mature ‘Mittelstand’ companies. These are not traditional tech liquidity events in the Silicon Valley sense; they are strategic consolidations where the acquirer values integration, not revenue.

Private Equity (PE) is beginning to fill the gap, providing scale-up capital and facilitating roll-ups of complementary assets. This could become Europe’s most powerful defence finance mechanism with PE acting as the connective tissue between venture innovation and industrial delivery (Private capital in European defence: from peripheral sector to strategic imperative | Deloitte UK ). However, compared to other markets, namely the United States, European PE still lags considerably.

For founders and investors alike, it appears that the implication is clear that in general, they should design for integration, not independence. The real exit in defence is often ‘upstream’, into strategics or sponsors, rather than ‘out’ through public markets.

The Risk of Herding and the Need for Strategic Coherence

The current wave of private capital, while welcome, also carries systemic risk. In short, most investors and founders are running to where the ball is, rather than to where it is going.

Without coherent government signalling, alongside experienced disciplined investors with sector expertise, VC will cluster around the most visible, lowest-barrier technologies typically drones, cyber tools, and AI platforms, at the expense of deeper, harder capabilities.

This herding is already visible with hundreds of near-identical drone and ISR startups competing for the same contracts, chasing operational niches that are already saturated. This is further exacerbated if government backs generalist funds rather than specialist funds with domain expertise. When market correction comes, as it inevitably will, LPs will absorb the losses, and investor appetite for the sector will contract.

The result could be stagnation and premature consolidation, leaving capability gaps unfilled and industrial momentum lost. The solution is not to slow investment but to align it through published, coherent, capability priorities and defined procurement roadmaps, that guide and reward investors who specialise rather than chase fashion.

The Next Decade of Defence Innovation

The coming decade will redefine what counts as defence technology. The frontier will move from discrete products to an integrated system of systems. Quantum sensing, resilient compute, and next-generation energy systems will underpin operational advantage. The boundaries between software, hardware, and materials will blur as autonomy becomes embedded at every layer. The decisive innovations will be in integration and the orchestration of sensing, decision, and effect, as evidenced by Palantir in the US.

In this environment, the most successful funds will be those able to interpret mission need as investment thesis. Defence VC will thus evolve from thematic investing to capability investing, where the key question is not “What’s the total addressable market?” but “What’s the operational delta?”

This demands a new, specialist class of investor: half technologist, half strategist who is comfortable in both venture rooms and operations centres.

From Capital to Capability

The re-entry of VC and PE into European defence is one of the most consequential shifts in modern industrial history. It reflects a recognition that national security is no longer the preserve of states alone but is a shared enterprise of governments, innovators, and investors. In fact, this is the logical evolution of the now decades-long trend of the democratisation of tech.

Yet this opportunity is fragile. Without strategic coherence and without clarity on what capabilities matter and how and when they will be bought, the wave could break before it transforms the shoreline. Herding, hype, and policy drift could recreate the failures of past innovation cycles.

There is a compelling alternative in a mature defence investment ecosystem where government provides direction, private capital supplies agility, and industry delivers scale. Such a system would not just fund technologies but generate strategic leverage turning financial capital into national capability.

Defence VC is therefore not simply about returns; it is about relevance. If executed wisely, it could mark the moment when Europe and its allies rediscovered how to convert innovation into deterrence.