Europe has a lot to shout about when it comes to defence tech, with a growing cohort of startups looking to disrupt the large, incumbent primes.
Defence tech investment in Europe hit €2.5bn in 2025, more than double the €1.2bn raised in 2024. Activity is being driven by multiple factors: Russia’s war in Ukraine has dragged into its fourth year, while fresh conflicts have flared in the Middle East; geopolitical instability is the new norm, and warfare is evolving fast.
Early-stage dealmaking is gathering pace; according to Sifted data, pre-Series B defence startups have raised €556m this year already, compared to the €635m startups at the same stage raised in the whole of 2025.
However, experts think a number of things are stalling many of those companies from scaling, including government money going to the wrong places and a slower flow of growth and late-stage capital into the sector.
To generate a successful innovation ecosystem, Paolo Surico, professor of economics at London Business School, thinks Europe needs more of three things: “the government to fund areas of public interest; research institutes to push the frontier of knowledge; and the private sector to turn that knowledge into new products.”
If it gets that, “Europe will have the opportunity to catalyse this defence spending, not just to fight war and for national security, but also to build the ecosystem," he adds.
Fixing procurement
According to Surico, the most effective way to use government defence budgets is to spend on domestic R&D rather than acquiring equipment from foreign companies.
“One problem with Europe is not how much it spends on defence but the budget composition,” he says. “Too much is skewed toward procurement and much less on R&D compared to the US."
According to research platform The Defence Finance Monitor, around 80% of European defence budgets is currently spent on procurement, predominantly in the US, with only 20% focused on domestic R&D.
The platform also shows that collaborative procurement, where multiple organisations, departments or agencies pool resources to acquire defence assets, also remains at around 18% of spending, falling short of the 35% collaborative benchmark established by the European Defence Agency (EDA).
Too much is skewed toward procurement and much less on R&D compared to the US.
Surico thinks when defence spending is focused on procurement and existing weapons, the effects on economic growth tend to be small and concentrated in the short-term.
Focusing on homegrown defence R&D and innovation can increase a nation's long-term productivity by creating new technologies, processes and intellectual property, adds Chris Coghlan, a member of Parliament in the UK and former army reservist.
“Defence spending should be tilted in favour of R&D, because that’s what's going to drive economic growth,” he says. “Although the defence payoff may not be so immediate as buying kit off the shelf, it will dramatically improve our long-term defence capability."
Government defence contracts
In Europe, bigger government contracts tend to go to the existing, large defence contractors.
“There's not a lot of evidence that innovation comes out of these incumbent companies,” Coghlan says. “They’re incentivised to take existing technology and make it better.”
“These platforms and services might be outdated in a decade's time,” adds Ram Puvinathan, policy consultant and founder of The Business of Defence. “Investing in innovation puts new technologies right into the hands of frontline users much quicker.”
The European defence sector is also far more fragmented than in the US, says Puvinathan.
There's not a lot of evidence that innovation comes out of these incumbent companies.
“The US simply operates at a much bigger scale,” he says. “There are a lot more opportunities and institutions there that have been built to quickly test and procure innovation. There's a willingness to give large billion dollar contracts to startups in a way that we're not really seeing yet in Europe.”
In Europe, some nations demand sovereignty, preferring technologies built within their own borders. However, the continent also needs to make sure it doesn't “have too much regulation that prevents us from choosing the best technology from our allies," Puvinathan adds.
Reforming European Fiscal Rules
In 2024, the European Union updated its fiscal rules, granting member states leeway to increase their defence budgets without exceeding national deficit funding caps.
But Surico warns that this exemption has a flaw. Because this rule excuses military spending, governments are opting to buy off-the-shelf equipment from the US instead of within Europe.
There's a huge opportunity here for pension funds to invest alongside the government and create upside for long-term patient capital investors.
Surico advocates for a targeted innovation exemption by suggesting only R&D investments in homegrown defence startups are exempt from deficit limits.
If fiscal rules cannot be easily changed, Lisa Quest, head of UK&I at management consultant firm Oliver Wyman, argues the solution is to leverage alternative financing.
“We need to catalyse private sector finance alongside government spending to create investable opportunities,” she says. “There's a huge opportunity here for pension funds to invest alongside the government and create upside for long-term patient capital investors."
A common argument against the innovation-first approach is, although innovation is important, how can governments buy weapons today in case of emergency?
Surico points to the UK's Patent Box policy, a tax incentive designed to encourage innovation that costs the government around £2bn a year.
The policy allows companies to apply a lower corporation tax rate of 10% to profits earned from patented inventions and innovative intellectual property (IP). .
By scrapping this £2bn tax break, he says, the government could redirect those funds to buy existing defence equipment.
Building an innovation ecosystem
Surico, Coghlan, Puvinathan and Quest all agree that increasing defence budgets alone won’t automatically strengthen Europe’s defence sector.
To compete with the US and build up the continent’s sovereign capabilities, Europe and the UK must restructure their funding ecosystems, says Quest. The biggest problem in Europe is not the lack of early startups or seed funding, but the funds to retain companies past Series B, she says.
“We'll see American VCs write significantly larger cheques but we don't see the same happening in Europe at the same scale,” she says.
Europe has come a long way and is on a good trajectory.
Surico adds: “Often, the lifecycle of a European startup is born here, developed here and then when it gets beyond what Europe supports, it moves to the US, because it can get the late stage funding it doesn’t manage to get here."
Both Surico and Coghlan suggest late-stage startups should utilise funding from public institutions such as the British Business Bank and the European Investment Bank to ensure they can remain in Europe.
Those two institutions are already busy cheque writers. Earlier this year, for example, the British Business Bank backed Hadean — a startup building physical AI models for the defence sector — in its £11m (€13m) raise. Similarly, the European Investment Bank participated in a €150m round for autonomous drone developer Quantum Systems in February.
Puvinathan remains optimistic. “We should credit Europe. Compared to where we were a few years ago, it's incredible that we have so many specialist defence investors supporting brilliant companies. Europe has come a long way and is on a good trajectory.
“It's so exciting to see the level of innovation, the number of people and the type of talent that are choosing to build in defence.”
