Investing in Defense

Private equity is still a rela­tively young indus­try and conti­nuously evol­ving. The current climate is charac­te­ri­zed by a slow­down in exits and a chal­len­ging fund raising climate. Further­more, PE funds need to become more active in their port­fo­lio compa­nies and specia­lize in indus­tries and stra­te­gies. This is certainly no news to the industry. 

An inte­res­t­ing sector where there are ample oppor­tu­ni­ties to create value are dual-use compa­nies. Dual-use rela­tes to products and services that have both civi­lian and mili­tary appli­ca­ti­ons. Many start-ups and SME’s active in the dual-use domain are seeking capi­tal and support, to scale their acti­vi­ties in the current boom. Not many PE’s have the expe­ri­ence in this speci­fic niche, where exper­tise, know­ledge and network are even more rele­vant than other sectors. 

The chall­enge is to balance the growth between civi­lian and mili­tary axes, as the long-term funda­men­tals behind the current defense spen­ding boom could differ at the time such port­fo­lio compa­nies are about to be exited. Govern­ment spen­ding is histo­ri­cally not the most stable source of busi­ness, so it is vital to be diversified. 

The defense sector has tradi­tio­nally focu­sed on the air, land and sea domains. More recently, more focus has been added to the cyber and space domains. Deep tech­ni­cal know­ledge is needed for these two newer domains, presen­ting ample growth oppor­tu­ni­ties for specia­li­zed compa­nies and inves­tors. With the growing use of unman­ned vehic­les at the front, real-time access to data is beco­ming incre­asingly important, and new segments such as elec­tro­nic warfare are beco­ming more rele­vant than ever. 

Active Capi­tal Company has recently inves­ted in S[&]T Corpo­ra­tion, specia­li­zed in trans­la­ting space data into actionable insights. S[&]T serves Minis­tries of Defense, Space Agen­cies, but also climate and rese­arch insti­tu­tes with true dual-use capa­bi­li­ties. Further­more, Active Capi­tal Company is inves­ted in Photon­First, a photo­nic sens­ing company with strong focus on aero­space. We will complete another tran­sac­tion in this space later in September. 

Secu­rity, both cyber and natio­nal, is beco­ming a more inte­gral part of our world. At a The Hague NATO summit pre-event this spring, it was even suggested to add secu­rity to ESG, making it ESSG. This marks a para­digm shift in thin­king about this subject. 

A major hurdle in Defen­seTech is the shift from long-term procu­re­ment of heavy assets with large OEMs, to shorter-cycle invest­ments in inno­va­tion. This requi­res Minis­tries of Defense to adapt their procu­re­ment proces­ses and engage more directly with SMEs, who are strong drivers of inno­va­tion. Current frame­works often slow SMEs down with leng­thy accep­tance procedures. 

Scaling invest­ments in Defen­seTech requi­res long-term commit­ment from Minis­tries of Defence, backed by equity funding from the govern­ment. SMEs are key drivers of inno­va­tion, but without long-term contracts and clear end-user commit­ment, attrac­ting private invest­ment remains chal­len­ging. Govern­ments must acknow­ledge the central role of SMEs in meeting defence spen­ding targets and allo­cate funds to support this growth. Private invest­ments will follow suit. 

Rightfully inves­t­ing in dual-use compa­nies is regu­la­ted. The hurd­les are not only regu­la­tory, but a good under­stan­ding of the speci­fics of inves­t­ing in dual-use compa­nies is para­mount. The regu­la­tory frame­work should howe­ver be balan­ced in provi­ding the neces­sary safe­guard for public inte­rest, but also allow compa­nies and their share­hol­ders to be sustain­ably profi­ta­ble and be able to trans­fer ownership.