To Innovate in Defence, Europe Must Build Markets That Work for Defence Startups

We’ve heard for months now that European leaders are scrambling to increase defence spending, mindful that any ceasefire in Ukraine would need security guarantees, and that the present geopolitical unrest, as well as shifting national priorities, has made greater regional autonomy a necessity. This is unsurprising. Tools, weapons, equipment and manpower cost money. But money alone is insufficient for building the kind of infrastructure that will give Europe the ability to defend itself and act independently in the world. A reconsideration of how money is spent is also needed.

It would be easy to attack those who spend that money on their preference for big defence contractors. But we should take a more nuanced view. Those contractors have proven themselves to be reliable, the rock upon which European Defence has been built, and upon which a majority of the new European rearmament surge will be deployed. But with the increased role of innovation, in particular leveraging innovative “COTS” (commercial off-the-shelf) components developed for civilian use, space does need to be created for smaller, faster-moving companies, able to incorporate as fast as possible innovation into defence products. Innovation has always been vital for defence. There’s a reason we don’t see knights on horseback any longer: technology has moved on.

For innovation to flourish, we need to allow for this kind of creative destruction. That means nurturing an ecosystem in which companies can appear, develop, get tested, and if, if needed, die. But at the moment, that isn’t the case: defence startups face an uphill struggle to get the money they need to grow, develop their products and build a customer base. Investors see them as risky compared to – for example – software companies, whose business models are easier to assess, may be excluded from investing formally by their funds due to ESG or reputation considerations; and often have an instinctive aversion to anything military. Europe’s culture of peace has stigmatised defence.

Reality, in the shape of the conflict in Ukraine, is changing that, but venture capitalists with the appetite to invest don’t have the experience or expertise to invest intelligently in defence. This, unfortunately, is true even of a large share of the new of  funds aimed at defence investment. Vanishingly few investors really have the sector fluency and deep knowledge that a company in the space requires. At the same time, banks are also unfamiliar with the field, which makes them reluctant to support defence growth to build and expand factories, manage stock and hire workers. Europe’s stock markets, meanwhile, are scattered and weak. Fewer IPOs and fewer opportunities for investors to exit and reinvent makes the investment cycle sluggish and dysfunctional.

This can change. We’ve seen it happen. In the 1980s and 1990s, the biotech industry went through radical upheaval. The big companies stopped doing R&D in-house. They let venture capital build an ecosystem of startups to explore and evaluate new drugs and molecules, taking on the risk themselves and competing, and then bought the victors, reducing their own risk. Venture capitalists funded a wide range of small firms, mindful that they only needed a tiny number to be game-changers to justify the majority failing. And the model works. This is a functioning system of investment, growth and exit.

If defence can replicate this model, then Europe can make the most of its rich tradition of hard science, engineering, research and entrepreneurship to build up its defence infrastructure rapidly. It can achieve the strategic autonomy for which it has striven for more than a decade. If it can’t replicate this model, or can’t build the right environment, then we can anticipate that innovation will be faster in other geographies that do. If those geographies are allies, the impact will only be economical. If they are not, it may be more strategic.

Are there signs things are changing? Yes. Not only has the conflict in Ukraine thrown light on the vital need for Europe to have strong defences, and started to eliminate the stigma attached to defence investment, but companies are increasingly thinking of how their products can be ‘dual-use’ – can serve both civilian and military ends. Defence buyers are adopting off-the-shelf solutions, making startups more attractive for funding. This is a start. Our task now is to press forward, and to do so with the recognition that Europe’s long-term security depends on it.

**********

Jean-François Morizur is CEO of Cailabs

***

The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group