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Investors are typically an optimistic bunch, but every so often they’ll be candid about their worries about the sector they’re investing in. And last Friday at Berlin VC Project A’s PakCon defence event, investors and founders went deep on a couple of concerns about defence tech.
Some investors were worried about the exit opportunities for defence techs and what that might mean for the capital flowing in; meanwhile VCs and founders bemoaned the slow and cautious approach of governments when awarding contracts to startups as a barrier for the space.
Sluggish governments
Among governments generally, “the urgency is not there, the wish for innovation or disrupting has not been there,” Jeanette Hvam, CEO of Danish camouflage startup DECPT, said on stage. “The budgets are very much focused on these huge systems; startups only need a fraction of that to accelerate. We’re not that expensive,” she said.
“What we need, what is super critical, is user feedback,” she added — which startups can get through their products being used in Ukraine, or through procurement from more innovative people within governments, she said. Hvam suggested the special operation forces within militaries is where startups need to go to find those people. “They are risk-taking, they are okay with things not being certified.”
But it’s not easy: “Finding this innovative person within the government is like finding a needle in a haystack,” said Hvam. She added that governments need to have conversations with startups about what they need and how they get there, but do it a little “faster”.
While the US government has created “innovation” units to try and work on these things, Greg Shipley, a managing director at US non-profit defence investor In-Q-Tel, believes that’s the wrong approach: he said he’s asked people working in government procurement, “‘Hey, have you gone and talked to the innovation unit at Apple?’ There’s no innovation unit at Apple, Apple is just innovative,” he said. “There’s a cultural element in government organisations where there needs to be an appetite for trying new things, and then there also needs to be an appetite for tolerating risk and dare I say tolerating failure… Until you get that in there, it’s really hard.”
Uwe Horstmann, general partner and cofounder of Project A, doesn’t think it stops at cultural change; there also need to be incentives through things like promotions and pay within the government to work with startups.
It’s not all on the government’s shoulders, though: Kelly Chen, partner at the €1bn NATO Innovation Fund, said that governments are doing what they can to boost innovation, but that what’s needed is more private capital.
Worries of a VC retreat
Outside of governments, Shipley said he’s worried that there may not be enough exits for defence techs — which raked in $2.4bn last year — to keep big VCs interested.
He sees parallels to the space frenzy in the last several years: a lot of “successful, mainstream” VCs “dipped their toe” into space during the last several years, and post-2021 peak realised that “‘It's too capital-intensive, it takes too long,' whatever,” and that led to a big drop off in funding. “Now I have a bunch of portfolio companies that have to go out and raise Series B, and the number of VCs that they can raise from has shrunk massively just in the last two years,” he said.
“I worry that we're going to have a retraction on defence investing; I worry that if there aren't big exits, a lot of the mainstream VCs that are funding — especially the US ones that are now playing in Europe and funding defence-oriented companies — [will] decide, 'Eh, this isn't worth doing anymore, I don't see the returns'... What happens to those startups? What happens to the tech that those startups are develop[ing]?”
In my view Shipley’s concern is certainly valid: big VCs like US-based General Catalyst, Lightspeed Venture Partners and Accel are all throwing millions of euros at startups like German defence tech Helsing, which raised €450m back in July. But considering how difficult the government is as a customer for startups, and the murky exit options for these startups — which VCs privately worry to me won’t be numerous enough considering the tricky IPO markets and the types of acquirers that defence might attract — there could be some real problems on the horizon.
But, as Shipley pointed out: “I don't think we'll know for another couple years.”
I’d love to hear from you, readers: What big roadblocks or worries do you have about defence tech right now? How do you think startups or VCs can get around them? Send me a line.
