Recent wars and rising tensions with China have highlighted the Pentagon’s ongoing need to retool its arsenal with the latest technologies. VCs increasingly believe startups will play a meaningful role in these innovations.
VCs weren’t always comfortable investing in defense tech. For years, the sector was plagued by double whammies: It was seen as a morally controversial investment, and the process of securing government contracts was too lengthy and uncertain to justify venture funding.
But this has changed in recent years. National security became a priority amid the technological arms race with China. Many startups in the sector have also found ways to generate revenue from commercial applications while waiting for their shot to sell their products to the lucrative military markets. Leaders like Anduril, Palantir and SpaceX have further boosted confidence with a roadmap to success in military applications and multibillion-dollar valuations.
As a result, investor interest surged in startups developing satellite imagery, artificial intelligence, space tech, cybersecurity and autonomous robotics and other defense tech. US-based companies in the category collected nearly $100 billion in VC funding from 2021 to now, a figure that’s about 40% higher than what was invested in the seven prior years combined, according to PitchBook data.
VC’s appetite for investing in defense tech isn’t expected to slow down.
“Software-based defense systems [have come into] focus, and I imagine that will only accelerate given the recent events,” said Kirsten Morin, co-head of venture capital at HighVista Strategies, an asset manager that invests in venture funds. She added that she is coming across more managers who identify the sector as an area with attractive investment opportunities.
The US defense-tech market is expected to expand at a compound annual growth rate of about 16%, according to a recent PitchBook report. VC-backed companies will vie with traditional contractors such as Lockheed Martin and Raytheon for a piece of that rapid expansion.
While more generalist firms are considering adding defense tech to the list of investable sectors, Philip Bilden, managing partner at Shield Capital, a firm that backs early-stage “dual-use” commercial and military-tech startups, warns that the sector is difficult to invest in without specialized experience.
Last month, Shield closed a $186 million debut fund, significantly exceeding its $120 million original target. The amount stands out at a time when LPs have pulled back from emerging managers. What set Shield apart is that the firm was started by Bilden, a former HarbourVest managing director with connections to US military, and Raj Shah, previously a director of the Pentagon’s Defense Innovation Unit. Bilden emphasized that Shield’s ties to the Pentagon are a tremendous advantage.
“You’ve got to have very specialized skills and capabilities to actually make money [investing in this sector],” Bilden said. “You don’t just do this as a generalist.”
Opportunities in defense tech have become so attractive that some generalist funds are hiring partners with specific knowledge of the space or developing it in-house.
The sector now boasts a number of companies with billion-dollar valuations. Anduril, the maker of autonomous systems for warfare, was valued at $8.5 billion last year. Defense systems developer Shield AI raised $200 million at a valuation of $2.7 billion last month. And Skydio, which builds AI-powered drones, raised $230 million at a $2.2 billion valuation in February.
Secondary investors are also bullish on the sector’s future. Data from private company secondaries platform Zanbato indicates that the market now values Anduril at upward of $18 a share, a premium to the $16.52 per share price that the company garnered in its Series E last December.
While it may seem that defense tech is having a moment, serial entrepreneur Ben Lamm, who is best known for his de-extinction startup Colossal Biosciences, is convinced that VC interest in defense tech is here to stay. Lamm recently sold Hypergiant Industries, a defense-tech startup he founded in 2018.
“I definitely don’t think it’s a hype cycle,” Lamm said. “Defense tech will continue to grow. It will be a part of big funds’ core strategies, and you’ll see mid-tier [size] funds pop up to focus on the sector.”
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