Since Russia invaded Ukraine, opportunities and investments for European defense startups have increased significantly, according to industry experts. Government actions and investor moves are transforming an area that was once synonymous with slow-paced progress.
A study released in February by the NATO Innovation Fund (NIF) and market analysis company Dealroom revealed that investment from venture capitalists in European startups focused on "defense, security, and resilience" surged by 30% over the two years leading up to 2024, totaling $5.2 billion.
This indicated a transition that was happening even prior to Russia's comprehensive attack in early 2022, as "core technologies" started being modified for military applications, according to Patrick Schneider-Sikorsky from NIF, who spoke with AFP.
He cited "additive manufacturing, artificial intelligence, radio frequency technologies, and battery technologies" as areas that had already drawn investments prior to " sheer necessity" accelerating their application and development on Ukrainian battlegrounds.
However, the pressing requirement to advance cutting-edge battlefield technology — a swiftly evolving objective amid the turmoil in Ukraine — still faces numerous obstacles.
One of the biggest challenges lies in persuading investors – ranging from sovereign wealth funds and public banks to pension funds or family offices of affluent individuals – to invest capital in defense. This sector is frequently grouped together with “sin stocks.”
'Like gambling and drugs'
A company that encountered this issue is the German start-up Donaustahl, which quickly shifted focus from producing accessories for sport pistol shooting to crafting armed drones.
Despite generating significant attention at last year’s Berlin air and space trade show, “Donaustahl, being a defense firm, has thus far been excluded from financial support and capital market investments,” founder Stefan Thumann stated to AFP.
He lamented that it was "exactly like gambling and drugs."
Although Thumann mentioned that he is currently in discussions with potential investors, he also uniquely chose to reach out directly to the customers who support his business. He did this through an active online presence aimed at raising funds by offering digital bonds.
Navigating limitations related to defense technology or what are known as "dual-use" items—those applicable for both civil and military purposes—would necessitate amending current pacts governing how investment funds allocate capital, or establishing entirely new funds, according to Schneider-Sikorsky from NIF.
Some indications of progress have emerged from government bodies.
Last year, the European Investment Bank decided to eliminate the condition that "dual-use" firms they fund must obtain at least half of their income from non-military clients.
When examining European governments from an eastern to western viewpoint, one can observe a clear progression in their attitudes towards technology—from more aggressive strategies to more protective ones—according to Jack Wang, the UK Managing Director at the venture capital firm Project A.
For example, neighboring country Estonia, which shares borders with Russia, recently declared the establishment of a €50 million ($54.1 million) fund aimed at investing in defense as well as dual-purpose technology sectors.
Last month, Pia Santavirta, who leads Finland’s public investment fund Tesi, listed “defense technology” as one of the “emerging growth areas” they were considering.
Private investors are detecting opportunities worth trillions due to substantial planned expenditures hinted at recently by both Berlin and Brussels. In particular, Germany has modified its constitution to allow increased borrowing for defense purposes.
'Out in the cold'
At the opposite end of the spectrum lies the final consumer, where defense startups encounter military acquisition processes accustomed to dragging out transactions for several years.
"Most VC (venture capital) funds have got used to investing in software to sell to small businesses or consumers," Project A's Wang said, expecting their backing to "convert to revenue... within one-and-a-half, two years".
"The military sales cycle doesn't operate like that".
"Both cultures are going to have to change," said NIF's Schneider-Sikorsky.
Defence ministries may in future "have a defence tech company that is almost on contract with the military to produce and continuously upgrade capabilities, as opposed to just selling a bit of hardware that's going to be stockpiled," he added.
"Some countries just need to get away from their specific gold-trimmed solutions," Donaustahl chief Thumann urged.
We lack the time... I'm hoping the German army will update their purchasing process and eliminate certain overly complex barriers in bidding that end up freezing out smaller companies.
