Introduction
Investment in the defence, security and resilience sector is booming. Last year, investment reached US$5.2 billion in Europe (up 30% in two years), with European defence VC investment into the sector accounting for 10% of all VC funding across Europe. Whilst Europe has historically lagged behind the US in terms of investment into the defence sector, Europe is now catching up – in part due to the significant increase in public funding which has been announced since the Munich Defence Conference in February 2025.
Historically, private investors have tended to be wary of defence as a sector, and have avoided hardware-heavy industries such as defence due to their often intensive capital requirements. There were a multitude of reasons behind this, including: (i) it being common for limited partnership agreements which govern funds to contain restrictions preventing investment into the defence sector and defence-related entities (and some funds had ethical concerns); (ii) on the R&D side, where technologies generated from university research had potential defence applications, university intellectual property licensing policies typically prohibited use of such technology in the defence sector; (iii) buyers of defence products (typically government defence ministries) had long procurement cycles which would exceed the typical VC funding cycle (18 months to two years); and (iv) due to the limited number of buyers, earlier stage companies could not scale at volume. Further, fixed margin returns were a common feature in certain types of defence material supply contracts (typically for large systems and platforms with cutting edge technology, where the risk of cost overruns is high due to the complexity of the project (including the technology) – in these scenarios, the government takes the risk of cost overruns and so, in return, the margin from which the seller benefits would be regulated.
However, many of these historic barriers have either changed materially or have disappeared entirely. And as a result, investment into defence tech companies is undergoing a revolution.
Commercial landscape
Clearly, a key driver for increased investment stems from the significant increase in defence spending across Europe in response to recent geopolitical tensions. This investment surge is underpinned by substantial increases in national defence budgets across NATO countries, particularly following Russia's invasion of Ukraine in 2022. NATO members have committed to meeting the alliance's target of spending at least 2% of gross domestic product (GDP) on defence, with many countries now exceeding this threshold. More ambitiously, several nations are moving towards a new informal target of 5% of GDP on defence spending, recognising the need for enhanced military capabilities in an increasingly unstable security environment. The European Defence Fund (EDF) plays a crucial complementary role in this landscape, providing funds to support collaborative defence research and development projects across EU member states.
However, another key driver are the material changes made to defence procurement procedures by European governments. Traditionally, defence procurement processes have been inflexible and have tended to be dominated by the larger incumbent players (known as the big primes or Original Equipment Manufacturers (OEMs)), which operate at scale with sizeable R&D functions, but which adopt relatively risk averse commercialisation strategies. As a result, smaller innovators were effectively shut out from opportunities. That position is now changing. In the UK for example, the government announced in February 2025 a new defence innovation body which will simplify and streamline interaction between the Ministry of Defence and innovative firms so as to allow for the rapid procurement, scaling and deployment of cutting-edge military technology.
Another key development is the shift away from cost plus fixed pricing models towards a more dynamic pricing system. Cost plus models favour incumbents with large, scaled manufacturing bases, and poses a challenge for growth businesses which are in the process of scaling. The shift away from fixed pricing creates an opportunity for innovation and growth, which until now has not existed.
Underpinning all the above is the change in the nature of warfare and a new paradigm in which the recognition (triggered by the Ukraine war) of the potential for advanced technologies (drones, autonomous systems, software etc) deployed at a much lower price point, but in high volumes, to project force and cumulatively offer a realistic prospect of matching the hardware-heavy approach to defence of the old paradigm. This has had profound implications - it helps cash-strapped governments to rearm more quickly and in a cost-effective way, so there is strong buy-side traction from customers. It also means the capital requirements of a defence tech company can but substantially less, and within the reach of VC funding.
Private investment
The net result of the macro-political environment and the changes above has been a much greater willingness of private capital to enter the sector.
In particular, there are an increased number of defence-focussed VC funds which have come into existence (for example Shield Capital) and there is a growing trend amongst generalist VC investors to turn towards investments in the defence space. Appetite amongst generalist funds which are investing in the sector remains mixed, with some generalist funds limiting investment to dual-use items, whilst others being open to investment in defensive weapons (such as surveillance, threat detection and interception). But the trend is nonetheless clear. Examples of generalist funds deploying capital in the industry include a16z and Founders Fund backing Anduril Industries and a16z investing in Shield AI in the US, as well as General Catalyst investing in Helsing in Germany.
Funding providers are also countering the suggestion that investment in the defence sector goes against ESG principles, with ‘D’ perhaps being the new addition to the acronym. The realisation that there cannot be effective ESG principles without a secure geo-political landscape to support them has resulted in defence stocks held by ESG focused funds rising from EUR2.7 billion in Q1 2022 to Eur8.4 billion in Q4 2024.
Other funding models
Notwithstanding the flow of private capital into the sector, other funding opportunities remain available for growth businesses. In particular, the UK government and EU are increasingly willing to provide grant funding to defence technology companies to help them innovate and scale at pace. This includes the EU European Defence Fund (which has a budget of nearly EUR7.3 billion for 2021-2027) and the UK Defence and Security Accelerator (as part of the Ministry of Defence), both of which offer various forms of grant funding. Public funds, such as the NATO Innovation Fund, are also highly active within the sector.
Another funding option is to team up with established players in the industry – for example, a recent trend is for drone manufacturers to partner with larger companies to facilitate a rapid scaling of their manufacturing ability, as well as to provide enhanced offerings in relation to areas such as servicing and product maintenance. Either the larger company takes an equity stake in the business or they enter into a form of JV whereby the larger company provides the capital for the business to deploy and/or produce their technology.
Foreign direct investment
Given the innate nature of the sector, national security and foreign direct investment legislation will be relevant in the context of an equity investment into a company which is active in the defence sector. This tends to be the case regardless of whether the entity produces military or dual-use items. Investment activity aside, the legislation is also typically broad enough to capture non-equity related transactions (such as certain IP licensing arrangements).
That said, unless an investor is taking a significant stake in the company, the investment may fall below the mandatory notification threshold. For example, the UK's National Security and Investment Act 2021 mandatory filing regime will only apply if the investment results in an increase in shareholding or voting rights to thresholds of over 25%, 50% or 75%, or where a party acquires ‘material influence’. In a UK context, where a mandatory filing is required, the investor must obtain clearance prior to the transaction closing; closing a transaction prior to clearance being obtained will result in the transaction being void (and constitutes a criminal offence).
Obtaining clearances should be factored into timelines when thinking about transactions.
Conclusion
Recent changes in defence strategy across Europe (including from the UK government) mark a significant turning point in how governments and private capital approach military innovation. By combining a clear policy direction, increased funding, and industry reform, defence is no longer just a matter of national security - it’s also a key sector for innovation, investment, and sustainable economic development.
At Taylor Wessing, we are proud to advise many of the companies and investors driving this transformation – from early-stage innovators to global primes – and to support the legal, regulatory and strategic needs of those leading the future of defence.
