The defence venture complex - the numbers don't stack up

The Chief of the General Staff’s January call to arms[1] for the financial sector was a welcome message to those of us who have founded, or work within, the UK’s growing ecosystem of defence Small and Medium-Sized Enterprises (SMEs). While the intent behind the statement is commendable, its successful implementation demands a deeper understanding of the structural challenges from the perspectives of investors, investees, and government procurers alike.

Historically, early-stage defence companies have been marginalised by financial institutions (debanking[2] is only recently achieving much needed attention), largely ignored by investors, and left to operate in a procurement environment more comfortable engaging with established defence primes. This longstanding imbalance is finally receiving overdue attention, but deeper, more systemic issues remain unresolved.

Though these challenges have been widely discussed, what is often overlooked is a nuanced understanding of how investment in the defence sector actually materialises and whether these decisions are rooted in a realistic appraisal of the market. From the military’s side, there is a significant gap in understanding how, when, and why capital markets choose to invest. Conversely, many investors appear to misjudge the true scale and nature of the opportunity that defence represents.

Encouraging examples do exist, Anduril, Palantir, and Helsing have all gained international recognition, but this progress remains relatively superficial. It is still largely non-British in character and continues to focus heavily on “dual-use” technologies. The branding of most venture-backed defence firms in this manner reveals two important insights. First, investors frequently misunderstand the nature of legacy defence players, who in fact tend to operate across a wide range of military-specific technologies. Second, it reflects a lack of confidence in the market’s ability to sustain companies focused solely on defence applications.

This leads to a key irony. While the most successful defence companies are broad and diversified, recent investment has disproportionately targeted startups offering narrow, highly specific solutions. Anduril stands out as a rare exception, it identified this mismatch early and has aggressively expanded its scope through rapid capability development and strategic acquisitions, including its takeover of Microsoft’s Augmented Reality IVAS programme. It remains to be seen, however, whether the scale of capital required to achieve this can realistically be recovered, in the longer term, through public market valuations.

At its core the disconnect is this, investors are seeking scalable growth while the Ministry of Defence (MoD) is seeking innovation. As the saying goes, "money goes where it is respected and stays where it is nurtured." Unless defence proves capable of both, and unless the current structural inefficiencies are addressed, the intent of recent rhetoric will remain unfulfilled. Worse still, markets may already be responding to political signals rather than actual opportunity, resulting in chronic overcapitalisation. This misalignment risks forcing the MoD to overextend limited resources to protect market positions, even when the scale of opportunity was originally overstated.

This brings us to the crux of issue. Why, and more importantly when, do defence companies seek venture funding? Timing is crucial. Should scale-ups raise capital early, based on imperfect understandings of their market? Or should they wait until post-revenue, when the real scale of the opportunity becomes clearer, though often smaller than initial expectations?

Neither path is perfect. Whether a company grows organically or with venture backing, it will eventually have to confront the realities of the procurement system. The choice for founders is whether to face those challenges early by “front-loading” or later through “back-loading”.

The goal of this piece is to encourage more objective analysis from both investors and the MoD: investors need clearer assessments of market scale and sustainability, while the MoD must understand that the procurement ‘oil tanker’ must turn faster. If not, the current softening in defence investment risks becoming a bubble. Founders who achieve lofty, but ultimately unsustainable, valuations may be left with little choice but to exit UK defence, or the sector altogether, simply to generate a return.

Organic Growth (front loading)

The most conventional route to growing a defence company is through organic means. However this approach, specifically with defence, presents a number of fundamental challenges some of which are outlined below;

1. Multi-year/non-competed revenue: Early stage company’s major source of revenue with the MoD is competed in-year CDEL (Capital Expenditure (CapEx)). This is compared to primes (who compete for as little as 10% of their revenue[3] and whose contracts are, on average, 13 years[4] in length incorporating both CDEL and RDEL (Resource Expenditure - OpEx)). This structural disparity means scale-ups are in a constant cycle of chasing short-term contracts just to stay operational, with no opportunity to invest in long-term growth all while competing against incumbents with decades of projected cash flow.
2. Experience and provenance: Despite progress within MoD Commercial and the 2024 procurement reforms, it remains a stated reality that unless a bidder can demonstrate prior experience delivering at the intended scale, contracts are highly likely to be awarded to those who can. This results in a slow, iterative growth path for scale-ups. One that constrains innovation and keeps newer entrants trapped below the threshold of meaningful delivery.
3. What, or rather how, the MoD buys: Despite repeated assurances to the contrary, the MoD does not buy ideas, it buys programmes. This means it procures well-defined capabilities aligned to budget lines and requirements, rather than investing in early-stage innovation and allowing their application to evolve. A common example is the number of promising DASA funded projects that fall into a funding gap once the grant ends, due to misalignment with the acquisition pipeline. Scale-ups excel at fast, agile product development, not running multi-year, multi-stakeholder, programmes. That said, this dysfunction affects incumbents too. Their single-digit operating margins reflect not excess profit, but the weight of bureaucratic burden of being part of the MoD’s supply chain. This is critical for two reasons: first, the belief that challenger technologies will remain cost-effective post-procurement is currently unfounded. Second, long-term company valuations must reflect the lower margin environment that characterises defence, in contrast to sectors like consumer tech.
4. The pull of easier revenue: Given the difficulty of selling products or ideas to the MoD, alternative revenue sources, such as dual-use commercial markets or consulting services through frameworks, become an attractive and often necessary diversion for small companies. Yet this has a cost. The UK risks squandering its most innovative talent on services rather than solutions, as technical founders shift focus to consultancy just to survive. The MoD must do more to nurture and retain this talent, not by paying it a day rate, but by creating an environment where focused, product led innovation is economically viable. The ongoing emphasis on dual-use opportunities, while politically convenient, is increasingly a form of displacement. One cannot blame private capital for prioritising dual-use strategies when MoD budget allocations themselves reinforce that very logic.

To overcome these barriers, scale-ups face two distinct paths. One is to fight through the so-called “valley of death”[5], often a decade-long process, to gradually build the experience, product breadth, and contract diversity needed to challenge incumbent primes. This path is fraught with risk and rarely offers the structural stability needed to scale efficiently.

The alternative is to leapfrog these constraints. A growing number of defence scale-ups are now raising sufficient capital to hire seasoned personnel, develop products aligned with multiple budget lines, and present a perception of financial stability that gives the MoD confidence. Yet this strategy carries its own risks. The slow, iterative approach, though arduous, allows companies to develop a fingertip feel (Fingerspitzengefühl[6]) for their markets, discerning between genuine new funding and what ends up being reallocated budgets. By contrast, poorly timed or poorly understood venture-backed scaling can doom a company before it truly begins.

Venture Capital (back loading)

Given the complexity of selling to the MoD, venture funding holds clear appeal for defence startups. Before going further, however, it’s worth revisiting what venture capital actually is, and what it expects in return.

“Venture funding is intended for high growth companies, in the next stage of it’s innovation life cycle. The period in a company's life when it begins to commercialise its innovation, building the infrastructure required to grow the business (manufacturing, marketing etc.) as well as improving the balance sheet (providing fixed assets and working capital).

Venture money is not long-term money. The idea is to invest in a company's balance sheet and infrastructure until it reaches a sufficient size and credibility so that it can be sold to a corporation or so that the institutional public-equity markets can step in and provide loner term liquidity”

Zider, B (How Venture Capital works, 1998, Harvard Business Review[7]).

Put simply, venture capital demands relatively quick and substantial returns, an expectation fundamentally at odds with the long, complex, and bureaucratic sales cycles typical of defence procurement.

Aside from the well-known challenges in the UK’s defence venture ecosystem, such as limited capital availability and ESG-driven investment constraints, this return mismatch creates a mirror-image problem to the one posed by organic growth. While venture funding enables faster early-stage development, it also raises the stakes. Companies must pursue significantly larger, and often unrealistic, sales targets to meet investor expectations.

This misalignment is further compounded by a deeper, more systemic issue. Namely a persistent misreading by financial markets of the true size and structure of the UK defence “pie”. Taking total defence spending from 2022/2023[8] the spending of £52.8b can be broken down by personnel (£13.8b), Equipment Support (£8.2b), other OpEx (£10.5b Infrastructure etc.) and R&D (£2.1b).

Leaving £18.2b for CapEx items (both Single Use Military Equipment (SUME) and dual use equipment – which is broken down further to around only £7.2b being spent on “hardware”[9]). If we assume a substantial portion of this is already committed or over-committed[10], the remaining addressable spend becomes dramatically smaller. To further complicate matters, there are already 19[11] strategic suppliers (plus other large vendors with annual recuring revenues (ARR) >£100M[12]), whose combined annualised revenue, sourced from both CapEx and OpEx, totals £16.1b. These incumbents are not only deeply embedded in existing programmes but are also aggressively competing for any incremental “new” money.

To simplify take, for example, a hypothetical UK-based drone company. On paper, its total addressable market might appear to be the entire £7.2b allocated to hardware (all numbers pre-SDR). But practically speaking, that would require replacing a vast array of other essential purchases (e.g., rifles, uniforms, vehicles). According to the MoD’s Equipment Plan, just £14.4 billion is allocated to “Weapons” over the next 10 years, equating to £1.44 billion per year. If we assume that 85% of the market is already contractually committed (as implied by the £16.1B/£18.2B ratio), then even complete dominance of the remaining “free space” would yield a maximum potential (ARR) of roughly £210 million.

This figure, while theoretically impressive, is far below the revenue needed to justify the implied valuations of many seed and Series A defence startups.

A natural rebuttal might be: “But the drone market will grow.” Undoubtedly. However, as with nearly every major defence innovation in recent years, it is likely that incumbents will capture the majority of any new spending, due to their existing relationships, contracting experience, and delivery track record.

This misreading of both the scale and nature of defence spending, combined with a failure to recognise defence as a mature and highly contested marketplace, has led many startups to overcapitalise. They enter the market with inflated expectations in a sector offering limited short-term growth and then struggle to justify their lofty valuations. The result is often a slow-motion collapse, a Wile E. Coyote moment, where the fall was inevitable long before gravity finally takes hold. 

To illustrate the challenge, consider another worked example. Suppose a defence company receives a £100M enterprise valuation (EV) during a Series B round and raises £20M, an amount that is realistic in order to scale a defence business. In this scenario, investors would typically be targeting a 5 x return over a five-year horizon, meaning they’d expect the company to reach an EV of around £500M within that period. Even extending the window to ten years, this level of growth, while not impossible, is considerably more difficult to achieve in defence than in higher-velocity markets such as consumer electronics or SaaS.

Based on average steady-state defence acquisition multiples (2.2x revenue or 13.7x EBITDA[13]), the company would need to generate either £227M in ARR or £36.5M in EBITDA to support that £500M valuation. To put this into perspective, that level of revenue would place the company among the top 20 defence suppliers in the UK, alongside firms that have been operating for more than 80 years.

And this doesn’t even account for the “power law” dynamic inherent in venture capital, where roughly 20% of portfolio companies are expected to drive the majority of fund returns. In that context, the targets for a ‘successful’ outcome may be even higher. Put simply: for venture capital to work in defence, a startup would need to become a market leader within 10 years, inside one of the most structurally entrenched and slow-moving industries in the world. Anduril’s current success in doing so is very much the exception, not the rule.

Naturally, this analysis focuses on the UK market. In reality, many defence startups must look to larger ecosystems, such as the U.S., to make their growth trajectories viable. But once a company realises its domestic market cannot support its ambitions, the UK risks losing not just the company’s revenue, but also its IP, workforce, and strategic value. This dynamic could be exacerbated by the re-emergence of market protections, such as U.S. tariffs or domestic-first procurement policies. Unless UK growth opportunities improve, the most promising startups will inevitably migrate to where capital, scale, and customers align more favourably.

Paradoxically, the issue may not be underinvestment in early-stage defence it may, in the current stagnating market, actually be over investment. Between 2014 and 2024, approximately £1.05b[14] was invested into 251 UK defence startups. If we make a significant and simplified assumption that this capital generally bought 25% equity stakes in each company, investors would require combined company EVs[15] of £21b to achieve 5x returns on their investments (i.e., £1.05B x 4 x 5). To support those EVs, the startups would need to generate around £9.5B in ARR, equivalent to nearly 50% of the UK’s discretionary defence budget, within the next five years. That’s an extraordinarily high bar.

 This is the crux of the issue, overcapitalisation. As illustrated in Image_002, the blue line shows the EV growth curve required for continued VC investment through Series A, B, C, and beyond. However, the red line, representing actual revenue growth in defence, typically lags far behind, creating a mismatch that leads to bloated valuations unsupported by real earnings. This disconnect eventually discourages further investment and, perhaps more worryingly, deters future founders from entering the sector altogether.

The challenge now is to bend the red line upwards, to shift from slow, linear revenue growth toward something that more closely resembles the green line in the illustration. Only then can defence startups provide the return profiles venture investors need, without being forced to pursue other markets or abandon the domestic market altogether.

So the critical question becomes: how do we move the red line northwards?

Solutions

1. Increased defence spending: The most obvious way to address many of the challenges facing UK defence scale-ups is through a meaningful and immediate increase in the defence budget. Crucially, that increase must happen now, not two years[16] from now, as financial markets are inherently wary of future political promises (just ask DFID). However, raising the budget alone won't solve the problem. Without concurrent reform of the underlying procurement system as well as other structural inefficiencies, additional spending may bypass the scale-up community entirely. Equally important is the need to allow, and actively encourage, profitability. Single-digit operating margins simply aren't attractive to large-scale venture capital. For perspective, Apple’s operating margin is currently more than three times that of Lockheed Martin[17], one of the most profitable defence primes. If the sector is to draw serious investment, defence companies must be expected to retain and grow profit, not be penalised for it.
2. Reform Procurement and Enable Spiral Development: Much has been said recently about the need to improve defence procurement. While this is undoubtedly true, an even greater concern is that any “new” funding might simply be allocated in the same way as the old, predominantly through non-competed contracts awarded to incumbent strategic suppliers. To meaningfully support the growth and investment case for scale-ups, a substantial portion of this new funding should be ringfenced specifically for them. This could be achieved through a clearly defined and ambitious SME spending target, explicitly focused on independent UK entities to avoid the “Brit-washing” of foreign subsidiaries or prime-owned fronts. Critically, this funding should be channelled through multi-year spiral development contracts, which would help reduce revenue volatility and provide scale-ups with the same stability currently afforded to prime contractors. It’s time for the MoD to buy partners, not just programmes. A targeted increase in budget, coupled with modernised commercial frameworks, could accelerate returns for UK venture capital, creating a virtuous cycle. Higher returns lead to greater investment, which fuels more innovation, and so on.
3. Destruction and Creation: The entrenched position of the 19 strategic suppliers in the UK defence ecosystem acts as a concrete ceiling, effectively suffocating the scale-up community. With average corporate ages more than double those of firms in the technology sector, it's clear that some new blood is essential if the UK MoD is to remain competitive in future conflicts. Schumpeter’s theory of creative destruction, the idea that economic progress depends on the dismantling of outdated incumbents to make way for innovation, is highly relevant here. He acknowledged the brutality of this process, but also its necessity. The MoD must come to the same realisation. While the current SME agenda is well-intentioned, it overlooks a fundamental truth: for some SMEs to thrive, they must eventually grow into strategic suppliers. This means that success for a scale-up may necessitate the displacement, or even failure, of an incumbent. If the government genuinely wants to attract significant private capital into defence, it must be willing to accept that disruption may be the price of progress. To use the simple analogy of a car park if there are only 19 parking spaces, and they are all full, either the car park needs to expand or one or two of the spaces need to be freed up. Otherwise new cars will park elsewhere. Should this not happen investors and founders alike will lose faith that the risks of entry can ever be offset by future upside.
4. Hybrid and patient investments: The responsibility for change does not lie solely with the MoD. If financial markets are serious about deploying capital into defence, they must develop investment methodologies that reflect the sector’s unique characteristics. Specifically, longer return horizons and lower acquisition multiples. One promising avenue is hybrid investment models, or capital strategies underpinned by tangible assets. A recent example is the Series C[18] investment in U.S. based Saronic, which is using the funds to build its own shipbuilding facility, “Port Alpha.” In this case, the value of the physical asset helps anchor the enterprise valuation (EV), easing pressure on founders to deliver rapid revenue growth while still allowing meaningful capital deployment. On a more sobering note, investors must also become more realistic about what the defence sector can and cannot offer. That requires greater sector expertise and a sober reassessment of expectations. Defence is unlikely to be a panacea in a stagnating global economy, and valuations may need to be tied more closely to the slower, red revenue growth line from Image_002, rather than the aspirational green line. Similarly, returns may need to be evaluated over a much longer horizon than is typical for traditional venture capital.

 The cost of inaction

There are viable, actionable ways to realise the MoD’s ambition of fostering a thriving defence scale-up ecosystem. But doing so requires objective, meaningful reform, anchored in measurable targets and a hard truth. That no market can serve all interests equally. Defence is no different. As a nation, we must ensure that our most innovative minds and ambitious companies are able to succeed here, and are not forced to seek opportunity in other markets or sectors. And if that success demands the dismantling of elements of the legacy industrial base, then so be it.

To shy away from that reality is not to preserve stability, it is to accept stagnation. Failure to act will leave the UK, and by extension the NATO alliance, without the technological force multipliers we so desperately need to compensate for our declining mass. In the wars of the future, it will not be the number of platforms that counts, but the speed, intelligence, and adaptability of the systems we build atop them. If we cannot clear the runway for the next generation, we will never get off the ground.

[1] https://www.thetimes.com/uk/defence/article/defence-industry-shunned-by-virtue-signalling-investors-says-head-of-army-schrf77s6

[2] https://committees.parliament.uk/committee/158/treasury-committee/news/201265/small-businesses-are-facing-needlessly-tougher-circumstances-due-to-actions-of-banks-and-regulators-mps-find

[3] https://www.gov.uk/government/statistics/mod-trade-industry-and-contracts-2023/mod-trade-industry-and-contracts-2023 (Figure 10)

[4] This is based on the total contract length of 10 example Cat A programmes including some of the best known recent procurements such as Ajax (15 years), Dreadnought (24 years), Protector Drones (9 years), Challenger 3 (9 years).

[5] https://committees.parliament.uk/work/4548/bridging-the-valley-of-death-improving-the-commercialisation-of-research/news/

[6] https://en.wikipedia.org/wiki/Fingerspitzengefühl

[7] https://hbr.org/1998/11/how-venture-capital-works

[8] https://assets.publishing.service.gov.uk/media/660d4b5197e60600112b2218/MOD_Defence_in_Numbers_2023.pdf

[9] https://assets.publishing.service.gov.uk/media/5ca720f0ed915d0ada00e333/20190405_SME_Action_Plan_2019.pdf

[10] https://researchbriefings.files.parliament.uk/documents/CBP-8175/CBP-8175.pdf Para 5.1

[11] https://assets.publishing.service.gov.uk/media/5ca720f0ed915d0ada00e333/20190405_SME_Action_Plan_2019.pdf

[12] https://www.gov.uk/government/statistics/mod-trade-industry-and-contracts-2023/mod-trade-industry-and-contracts-2023 Figure 6

[13] https://www.kippsdesanto.com/insights/

[14] https://www.beauhurst.com/research/uk-defence-tech-2023/

[15] The combined EV of the 251 Defence assets into which £1.05b has been invested.

[16] https://www.gov.uk/government/news/prime-minister-sets-out-biggest-sustained-increase-in-defence-spending-since-the-cold-war-protecting-british-people-in-new-era-for-national-security#:~:text=The%20Prime%20Minister%20has%20today,of%20GDP%20from%20April%202027.&text=Defence%20spending%20to%20increase%20to,3%25%20in%20the%20next%20parliament

[17] https://news.lockheedmartin.com/2025-01-28-Lockheed-Martin-Reports-Fourth-Quarter-and-Full-Year-2024-Financial-Results and https://www.apple.com/uk/newsroom/2024/10/apple-reports-fourth-quarter-results/

[18] https://www.reuters.com/technology/saronic-technologies-valued-4-billion-after-600-million-fundraising-2025-02-18/