Russia's full-scale invasion of Ukraine and the war in the Middle East have led to changes in the approaches of major players in the defense market.
Due to the perception of the threat from Russia and other geopolitical conflicts, Western countries have begun to pay more attention to their defense capabilities. Taking advantage of favorable conditions, many entrepreneurs and developers are adapting their solutions for military use.
Venture investing
The emergence of a large number of breakthrough companies is supported by a rapid increase in the volume of venture capital investment. According to Pitchbook, the volume of investments between 2015 and 2023 increased 12-fold - from 412 million to 5 billion euros, and only 10% of them were carried out in Europe, and 82% in the United States. One of the key reasons is that the financing of military technologies is a difficult topic for institutional investors who are investors in Europe's leading venture capital funds.
Institutional investors generally don't invest in defense technology because they don't want to be associated with tools that bring death to other people. Even if these people are Russian occupiers. But in the United States, many large and well-known investors, such as Andreessen Horowitz, New Enterprise Associates, Google Ventures, Founders Fund or General Catalyst, have had at least 80 deals each in the field of dual use tech since 2016.
The driver of the change in the principles of the funds is the large-scale investments of European countries in their own rearmament after February 2022. Most NATO members are approaching the defense spending target of 2% of GDP, and discussions are already underway to raise this figure to 3%. Thus, Germany, in the spring of 2022, created a fund of 100 billion euros to modernize its own army. This climate creates conditions for the emergence and development of dozens of companies that develop solutions for the military in the fields of cybersecurity, intelligence, drones and other technologies.
In addition, NATO's announcement of the $1 billion NATO Innovation Fund to support start-ups developing technologies of strategic importance for defense and security purposes marks a key moment in the integration of innovation in the defense sector.
But so far the domestic market has not felt these changes. Western venture capital funds invest in defense companies based in NATO countries. Ukraine has become a testing ground for them, where developers bring their solutions to test them on the real battlefield. Our companies are not the focus of Western funds.
New technologies against invasion
Defense technology, or defense tech, covers a wide range of innovative solutions designed to improve the capability and effectiveness of armed forces. The main common characteristic of most startups in this space is a dual-use focus.
This means that when companies develop solutions for military use, they make them relevant for civilian use as well. This allows them to expand their potential market and not be dependent on geopolitical changes.
Among the key areas in the field of technological defense innovations, military drones and robots stand out. The fighting in Ukraine has demonstrated the importance of unmanned aerial vehicles for reconnaissance, engagement and communications. There is also potential for ground-based autonomous robots capable of mine clearance, transportation, evacuation of the wounded, and even fire support.
Leading European companies developing autonomous robots include ARX Robotics, supported by the German Ministry of Defense, and Estonia's Milrem Robotics. Thus, the Estonian company’s THeMIS robotic platforms are already actively using APUs, and the parties are discussing joint production.
An important effect of rising geopolitical tensions has been the increase in cyber threats. Hacker groups are increasingly targeting Europe's digital infrastructure, putting critical infrastructure at risk. This sparked a boom in the region's cybersecurity market, which doubled between 2016 and 2023 to $41 billion.
Another area where tech companies are helping the military is in intelligence. The ability to use aircraft and satellites with innovative hardware and software components to better understand enemy actions provides a significant advantage on the battlefield. One of the leaders in this is Germany's Quantum Systems, which specializes in unmanned aerial systems that provide critical aerial reconnaissance. Interestingly, the company has a research center in Ukraine.
But Ukrainian developers also have something to offer in this direction. Local engineers have made significant progress in the development of drones and are producing a dozen models of reconnaissance UAVs that will be able to compete in the global market in the future. Particularly worth noting is Shark, manufactured by Ukrspetssystems, and Leleku-100 from DeViRo.
The boom in artificial intelligence (AI) technology has not spared military affairs. With the latest machine learning technologies, analysts can automate and accelerate the process of strategic data processing. Thus, one of the leading companies in this direction is the French Preligens, whose systems are capable of independently processing satellite images.
But the most ambitious company developing AI for military purposes is Germany's Helsing, which describes its technology as "artificial intelligence to defend democracy." The company's platform is capable of collecting data from various types of assets on the battlefield, creating the most accurate map of battlefields to make effective, as well as morally superior, decisions. Helsing has been operating in Ukraine since 2022.
Ukrainian developments
After the Russian invasion, hundreds of enthusiasts appeared in Ukraine who are developing new solutions to help destroy the enemy. As of March 2024, more than 1,200 projects were registered in the domestic cluster for the development of military technologies Brave 1. But most of them are in the early stages of development, and their teams do not have the experience to turn projects into full-fledged businesses.
One of the main obstacles that young developers of Ukrainian defense solutions face is finding funding. To change the situation, Ukrainian companies should adhere to the following recommendations:
Develop a product that will have the prospect of either dual use or sale abroad.
Do not be afraid of partnerships with foreign companies, especially those with experience in selling military equipment in their markets.
Be ready to give up part of control over the company on market terms: up to 10-15% of the company - at the Pre-Seed round and 20-30% - at the Seed round. Remember, it’s better to build a successful company but end up with a 10% share than to end up with a “garage idea.”
Take into account the peculiarities of the European venture market and do not waste time on funds that cannot invest in defense tech companies, even dual-use ones.
In the early stages, it makes more sense to focus on accelerators and private investors, who are much more flexible. They do not have to negotiate investments according to their own mandate, as in investment venture funds, which often have institutional investors as investors.
At later stages, when a ready-made and proven product has already been created, it is worth looking for foreign venture funds that have several defense tech companies in their portfolio. The defense sector in the West is extremely regulated, so having an experienced investor can greatly help with sales.
In the context of defense tech, Ukraine has the opportunity to take a share in the dual-use and defense technology sector, given the current macroeconomic situation and interest in security technologies. The global geopolitical situation shows no signs of normalization, so even after the end of the Russian invasion, military technologies created on the basis of real combat experience will be in demand in the world. But the path to international markets will be quite difficult, and the result will be a significant success if at least five companies achieve stable sales not only in Ukraine, but also abroad.
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Russia's actions have changed the attitude of European countries to the issue of defense, which has turned the former phantom defense tech industry into one of the most interesting regional venture areas. Given the relative newness of these changes, the European defense industry is undergoing a transformation, which creates a window of opportunity for Ukrainian companies.
