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VCs go outside their comfort zone with bets on defense tech

Investors see aerospace and defense tech as a hedge against the market downturn.

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After years of shunning investments in military and security-related technology startups, VCs are raising their profile in the sector as part of the US effort to gain a technological upper hand against new threats from adversaries like China and Russia.

More investors have also flocked to portfolio companies whose satellite, robotics and software tools can do double duty as military and commercial “dual-use” technologies.

This year has seen $7 billion invested in VC-backed US aerospace and defense companies through Oct. 13, according to PitchBook data. That puts the sector on track to surpass last year’s record deal value of $7.6 billion.

VCs’ growing appetite for those deals stands in contrast to their slowing pace of investment in most other sectors as the market slogs through a broad-based downturn.


The war in Ukraine is just one of the latest factors that put the spotlight on technologies that can protect critical national infrastructure and help deter attacks.

In addition, companies focused on defense and security are considered recession-proof. With the global economy drifting toward a possible recession, future revenues of SaaS-focused startups are under pressure as many corporate customers cut back their software spending.

By contrast, security-focused tech companies are gaining favor as the Pentagon continues retooling its modern arsenal with satellite imagery, data analytics, artificial intelligence, space tech, cybersecurity and robotics.

VC-backed companies that have recently won contracts from the government include Anduril, a developer of AI-powered defense systems that raised a $1.2 billion Series E at a valuation of $8.2 billion in May. Another is Skydio, an autonomous drone developer that investors valued at $1.07 billion. SpaceX, the most valuable VC-backed company, has also been awarded contracts from the US military.

“I think people realize that this is not correlated to the broad markets, and so, having some non-correlated assets is an important part of their portfolio,” said Mark Spoto, a managing partner at Razor’s Edge Ventures, a defense and security-focused firm.

When Razor’s Edge set out to raise its third fund last year, it initially targeted a $250 million vehicle. But LPs showed more interest in the firm’s strategy after the invasion of Ukraine, Spoto said. Razor’s Edge announced a $340 million fund last month, which was a 36% increase from the firm’s initial target.

The firm continues to receive calls from new limited partners who are asking if there is a way to invest in the fund via a secondary transaction, Spoto said.

VC interest in defense tech has also gained momentum amid an escalating technological arms race with China.

“The Department of Defense used to be the leader in R&D,” said venture capitalist Raj Shah, managing partner at Shield Capital and a former director of the Pentagon’s Defense Innovation Unit. “That is no longer. The best technology is now being developed in the commercial sector.” Shield Capital, which invests in security-focused companies, raised its debut $120 million vehicle in March.

“When we started our platform five years ago, Silicon Valley wasn’t paying much attention [to defense],” said Hamlet Yousef, a managing partner at Iron Gate Capital Advisors, a national security-focused fund-of-funds and direct venture investment firm. But since then, “the VC community realized that [the Defense Department] is a really lucrative buyer.”

Although the Pentagon is increasingly turning to Silicon Valley to develop cutting-edge technologies, securing those contracts still takes a long time and a lot of resources. “That is the reason investors [used to] advise startups to stay away from government contracts,” Shah said.

But in recent years, most companies in this sector start out catering to commercial customers and later expand to serving the military and intelligence communities.

Most VC funds tend to avoid investing in companies that are only focused on selling to the Pentagon, Yousef said. That’s because commercial uses help startups in this sector get initial revenue in the door.

Razor Edge-backed HawkEye 360 uses satellites to provide insights for the maritime and telecommunication industries. This year, the company has also performed over 1,000 individual missions over Ukraine on behalf of US and allied forces and intelligence agencies. The company was valued at $880 million last November and is currently looking to raise another round of funding, HawkEye 360 CEO John Serafini told SpaceNews in September.

But it wasn’t only the long sales cycle that deterred investors from defense-related tech deals.

“Since the early 2000s, you had a movement of people that felt that [working on these technologies] was taboo,” said Josh Wolfe, co-founder and managing partner at Lux Capital. “We felt it was a moral good to make sure that the United States defends our liberal democratic values. Why would you not want to equip women and men on the front lines [and] in all branches of our military with the best technology?”

Lux has been an early proponent of investing in defense technologies, having backed Hadrian, Saildrone, and Anduril.

Some VC firms continue to steer clear of military-related tech companies.

Palo Alto-based Playground Global has said it reduced its exposure to Skydio after the company, which initially made drones for consumers, diversified to serving government customers. While the firm was not legally required to sell its stake, it decided that defense tech was not a part of its investment focus.

In fact, many venture firms are prohibited by their LP agreements from investing in weapons. But defense tech investors, for their part, say the companies in their portfolios are not developing technologies for killing people.

“We’re not funding guns and bullets,” said Razor Edge’s Spoto. “We’re funding critical innovation that’s helping to create a strong defense that keeps us all safe.”

Featured image by Frame Stock Footage/Shutterstock

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    Written by Marina Temkin
    Marina Temkin covered the venture capital ecosystem from 2021 to 2024, based in San Francisco. Previously with Venture Capital Journal, Marina wrote about the VC industry, and she was a reporter with Mergermarket in New York and San Francisco. She also has been a financial analyst and is a CFA charterholder. Marina received an economics degree from the University of California, Davis, and she attended the CUNY Graduate School of Journalism.
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