Private equity and venture capital firms are pouring more capital into funding rounds for defense companies this year, as investors bet on disruptive new technologies and manufacturing models.
At nearly $2.6 billion across three quarters of this year, the total invested by private equity and venture capital firms into the defense sector has already exceeded the $2.2 billion full-year total for 2023, according to S&P Global Market Intelligence data.
The investment increase in the defense sector contrasts starkly with the broader decline in all venture capital investment so far in 2024. Between Jan. 1 and Sept. 1, funding rounds across all sectors totaled $181.9 billion globally and were on pace to fall short of the full-year 2023 total of $280.1 billion, according to Market Intelligence data.
The ongoing war in Ukraine sparked by Russia's 2022 invasion was a turning point, convincing a wider swath of venture capital firms to invest in weapons of war while also demonstrating how quickly those weapons were evolving, said James Cross, managing director of Franklin Venture Partners LLC and founder of the Silicon Valley Defense Group, a nonprofit focused on growing venture capital's role in the US defense industry.
The success of cheap, off-the-shelf drones in Ukraine highlighted the emergence of weapons that are low-cost, reusable and expendable.
"Silicon Valley believes the future of conflict will be automated, and we'll need a lot of cheap and versatile systems," Cross said.
Defense startups are benefiting from venture capital's search for growth opportunities amid a technology slowdown, said Matthias Duda, a managing director in NRC's corporate finance practice with a background in aerospace and defense M&A. Outside of hotspots like AI, tech startups have struggled under higher interest rates, increased regulatory scrutiny and declining investor sentiment.
"These VC funds have to put money to work somehow, and they see defense as a really opportunistic area to do that," Matthias said, noting that swelling national defense budgets in the US and elsewhere are an enticement.
Disrupting Global Arms Market
The opportunity to disrupt the US defense industry, which is dominated by a handful of prime contractors, is the "big prize" for venture capital firms, said Shana Marshall, an assistant research professor of international affairs at The George Washington University who studies the arms trade. A pervasive attitude in Silicon Valley is "that the government bureaucracy is slow and it's cumbersome and the weapons are too big and too expensive, and they don't match the wars that we need to fight," Marshall said.
Franklin Venture's Cross said the new approach to defense manufacturing is exemplified by startups like autonomous weapons specialist Anduril Industries Inc., which combines cheap, off-the-shelf hardware and AI-enhanced software in its drones.
Anduril's $1.5 billion series F round was the largest private equity- or venture capital-backed funding round targeting the defense sector between Jan. 1 and Sept. 1. Anduril aims to use the funding to "hyperscale" the manufacturing of its weapons, which include autonomous aircraft and undersea vehicles.
The Spike In Growth
The spike in the third quarter was driven by the Anduril deal. Nonetheless, venture capital investment in defense is clearly on a quarterly rise this year.
The Outlook For Defense Technologies
Whether defense startups eventually produce the kinds of exits that justify current levels of enthusiasm from venture investors is "the million-dollar question" for the industry, Franklin Venture's Cross said.
"It's probably healthy to be skeptical. I don't know that we'll have a giant IPO boom in defense tech," Cross said.
NRC's Matthias Duda noted that the turbulent geopolitical landscape seems unlikely to let up any time soon. The DOD’s continued emphasis on technology as a major factor for its mission is apparent with the creation of a multitude of initiatives, supported by rising budgets. The number of startups working on defense-orientated technologies is rising, backed by record venture investment. The DOD’s acknowledgement and efforts to support startups and help them bridge the Valley of Death will likely result in more successes, in turn fueling the interest in defense tech.
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