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Defense Technologies in Ukraine — Position of Venture Investors

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Defense Technologies in Ukraine — Position of Venture Investors © EPA-EFE/MIKHAIL PALINCHAK

Russia's full-scale invasion of Ukraine and the war in the Middle East have led to changes in the approaches of major players in the defense market. Being aware of the threat stemming from Russia and other geopolitical conflicts, Western countries have begun to pay more attention to their defensive capabilities. Taking advantage of favorable conditions, many entrepreneurs and developers are adapting their solutions for military use.

Venture investment

The emergence of a large number of breakthrough companies is supported by a rapid increase in the volume of venture capital investment. According to Pitchbook, the volume of investments between 2015 and 2023 increased 12 times — from €412 million to €5 billion, and only 10% of them were made in Europe, and 82% in the United States. One of the key reasons is that financing military technology is a difficult topic for institutional investors in Europe's leading venture capital funds.

Ukraine’s Two Wars: One Against Enemy, Other Against Defenders
Ukraine’s Two Wars: One Against Enemy, Other Against Defenders

Institutional investors usually do not invest in defense technology because they do not want to be associated with tools that bring death to other people. Even if these people are Russian occupiers. On the other hand, in the United States, many large and well-known investors, such as Andreessen Horowitz, New Enterprise Associates, Google Ventures, Founders Fund or General Catalyst, have had at least 80 deals each in the field of dual use tech since 2016.

The driving force of the change in the principles of the funds is the large-scale investment of European countries in their own rearmament after February 2022. Most NATO members are close to the defense spending target of 2% of GDP, and discussions are already underway to raise this figure to 3%. For example, in the spring of 2022, Germany created a fund worth €100 billion to modernize its own army. This climate creates conditions for the emergence and development of dozens of companies that develop solutions for the military in the fields of cyber security, intelligence, drones and other technologies.

In addition, NATO's announcement of the creation of the NATO Innovation Fund in the amount of $1 billion in support of startups developing technologies of strategic importance for defense and security purposes marks a key milestone in the integration of innovation in the defense sector.

That said, currently the domestic market does not feel these changes. Western venture capital funds invest in defense companies based in NATO countries. Ukraine has become a testing ground for them, where developers put their solutions to the test on a real battlefield. Our companies are outside the focus of Western funds.

ВАС ЗАИНТЕРЕСУЕТ

New technologies against invasion

Defense technologies, or defense tech, cover a wide range of innovative solutions designed to increase the capability and efficiency of the armed forces. The main common characteristic of most startups in this area is a focus on dual use.

This means that companies, when developing solutions for military use, make them relevant for civilian use as well. This allows them to expand the potential market and not be dependent on geopolitical changes.

Military drones and robots stand out among the key directions in the field of technological defense innovations. The combat operations in Ukraine demonstrated the importance of unmanned aerial vehicles for reconnaissance, attack and communication. There is also potential in ground-based autonomous robots capable of demining, transportation, evacuation of the wounded and even fire support.

Leading European companies developing autonomous robots are ARX Robotics, with the support of the German Ministry of Defense, as well as Estonia's Milrem Robotics. For instance, the Estonian company's THeMIS robotic platforms are already actively used by the Armed Forces of Ukraine, and the parties are discussing joint production.

An important effect of the growth of geopolitical tension was the increase in the cyber threat. Hacker groups are increasingly attacking Europe's digital infrastructure, jeopardizing critical infrastructure. This has fueled a boom in the region's cybersecurity market, which has doubled between 2016 and 2023 to $41 billion.

Another area where technology companies are helping the military is in intelligence. The ability to use aircraft and satellites with innovative technical and software components to better understand the actions of the enemy gives a significant advantage on the battlefield. One of the leaders in this is the German-based Quantum Systems, which specializes in unmanned aerial systems that provide critical aerial reconnaissance. It is interesting that the company has a research center in Ukraine.

But Ukrainian developers also have something to offer in this direction. Local engineers have made significant progress in the development of drones and are manufacturing a dozen models of reconnaissance UAVs capable of competing on the world market in the future. Shark, manufactured by the Ukrspecssystems company, and Leleka-100 from DeViRo are especially worth noting.

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The upsurge in the technology of artificial intelligence (AI) did not bypass military affairs. Thanks to the latest machine learning technologies, analysts are able to automate and speed up the process of processing strategic data. One of the leading companies in this direction is the French-based Preligens, whsose systems are able to independently process satellite images.

But the most ambitious company developing AI solutions for military purposes is Germany's Helsing, which describes its technology as artificial intelligence in defense of democracy. The company's platform is able to collect data from various types of objects on the battlefield, creating the most accurate map of combat operations to make effective and morally best decisions. Helsing has been operating in Ukraine since 2022.

Ukrainian developments

After the Russian invasion, hundreds of enthusiasts appeared in Ukraine, who are developing new solutions that will help destroy the enemy. As of March 2024, more than 1,200 projects were registered in the Brave 1 domestic cluster for the development of military technologies. However, most of them are in the early stages of development, and their teams do not have the experience to turn projects into full-fledged businesses.

One of the main obstacles faced by young developers of Ukrainian defense solutions is the search for funding. To change the situation, Ukrainian companies should stick to the following recommendations:

  • Develop a product that will have the prospect of dual purpose or sale abroad.
  • Don’t be afraid of partnerships with foreign companies, especially those with experience in the sale of military equipment in their markets.
  • Be ready to give away part of the control over the company on market terms: up to 1015% of the company in the Pre-Seed round and 2030% in the Seed round. Remember, it is better to build a successful company, but end up with a 10% share, than to be left with a garage idea.
  • Pay attention to the peculiarities of the European venture market and do not waste time on funds that cannot invest in defense tech companies, even dual purpose ones.
  • In the early stages, it is more appropriate to focus on accelerators and private investors, which are much more flexible. They do not need to approve investments according to their own mandate, as in venture capital funds, whose investors are often institutional.
  • At later stages, when a ready-made and tested product has already been created, it is worth looking for foreign venture funds that have several defense tech companies in their portfolio. The defense sector in the West is highly regulated, so having an experienced investor can help a lot with sales.

In the context of defense tech, Ukraine has the potential to take a share of the dual-purpose and defense technology sector given the current macroeconomic situation and interest in security technologies. The global geopolitical situation shows no signs of normalization, so even after the Russian invasion ends, military technologies created on the basis of real combat experience will be in demand globally. But the path to international markets will be quite difficult, and the result will be a significant success if at least five companies achieve stable sales not only in Ukraine, but also abroad.

***

Russia's actions have transformed the attitude of European countries to the issue of defense, which has turned the former phantom defense tech industry into one of the most interesting regional venture directions. Given the relative novelty of these changes, Europe's defense industry is at the stage of transformation, which creates a window of opportunity for Ukrainian companies.

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