Getting Traction in European Defence

Capital is flowing into European defence at a scale and speed that would have been unthinkable five years ago. Governments are raising spending targets, private investors that once avoided the sector are moving in, and a new generation of defence tech companies is attracting venture and private equity funding across the continent.

But the system through which that capital must travel was built for a different world. Procurement systems were designed for an era of relative geopolitical stability, when defence was largely a government monopoly, optimising for cost over speed. Environmental, social, and governance (ESG) frameworks and banking compliance regimes reflected a broader shift in capital markets that steered investment away from defence.

The result is a market defined by structural friction — in how capital is raised and moves across borders and how deals get done. The financial and regulatory architecture is changing but at different rates across the value chain and in different countries, although the European Commission clarified in 2025 that defence isn’t always incompatible with ESG. This poses real challenges for companies and investors that are critical to scaling European defence, but the firms and funds that understand the trajectory — and where it’s changing fastest — are already helping to shape the future. That means understanding how ESG consensus is shifting, why standard fund structures don’t fit, how each European market works differently, and what makes defence deals unlike any other. The firms that understand where the architecture is changing fastest — and can structure transactions accordingly — are already building a durable competitive advantage.

Ambition Versus Architecture

The scale of what is required makes the architecture challenge acute. European defence spending has risen by more than 60% since 2020¹ — and the pace is accelerating. The European Investment Bank increased its budget for defence in 2025 to €100 billion and European NATO members spent $454 billion on defence in 2024.² At last year’s NATO summit in The Hague, members set a new target for each country to spend 5% of gross domestic product annually on defence by 2035.³ That would more than double current levels for most European members, and it would increase annual spending to nearly $1 trillion collectively. Public capital vehicles — the European Investment Bank, national development banks, NATO innovation funds — can cover a fraction of the increase. Private capital will have to cover the rest.

The need for innovation compounds the challenge. Modern defence capability — autonomous systems, AI-enabled decision support, cyber, space-based intelligence — comes from fast-moving technology companies, not legacy primes building platforms over decades. The investors best positioned to back that kind of innovation are precisely those the existing financial and regulatory architecture was least designed to serve.

Four Structural Realities

Four structural realities shape how capital flows into European defence, and how it doesn’t. Each is evolving, but all present persistent challenges for the companies, investors, and advisers structuring their entries into the market.

The ESG Consensus Is Flipping

European capital markets spent a decade building a consensus that largely excluded defence from responsible investment. No single regulation drove this. It was a web of voluntary exclusions, internal compliance policies, and ESG mandates that accumulated institution by institution. The prevailing view was simple: Weapons cause harm, and harm is socially undesirable.

That consensus is now reversing. The European Union has explicitly reframed defence investment as ESG-compatible, the Commission stating recently that the Sustainable Finance Disclosure Regulation (SFDR), should not be interpreted to exclude defence-related activities. Large institutional investors that once screened out defence are revisiting their mandates.

But the reversal is happening slowly, unevenly, and one institution at a time. Further, while the Commission’s statements provide comfort that defence investments can be classified under Article 8 of the SFDR, the circumstances in which they could qualify as “sustainable investments” under Article 9 remains unclear.

Other barriers also exist. For example, defence companies with active UK Ministry of Defence contracts — vetted, security-cleared, and operating at the heart of the national security apparatus — have been unable to open basic bank accounts. Government policy isn’t the problem. It’s the internal compliance and risk frameworks of the banks themselves, which still treat defence exposure as a liability.

The ESG barrier isn’t uniform. It’s dissolving at different speeds in different institutions, jurisdictions, and limited partner (LP) categories. Fund managers that understand where it’s thinning fastest can access capital that others can’t.

Defence Economics Don’t Fit Standard Fund Structures

The companies Europe needs most — fast-moving, software-driven, iterating at speed — are exactly the kind that venture capital (VC) and private equity (PE) were built to back. But defence economics don’t map cleanly onto standard fund structures. Revenue, which can be substantial, comes from government contracts and arrives on government timelines. The path from prototype to programme of record (the formal process by which a military adopts and deploys a new capability) is long and uncertain. Exit options are also structurally constrained. Potential acquirers are few, cross-border transactions involving sensitive technology attract foreign investment screening, and European public markets remain thin for defence tech. These constraints have direct implications for how funds and their investments should be structured from the outset.

These constraints affect VC and PE differently. Venture capital is the natural financial instrument for early-stage defence tech companies, but the long path to revenue and the narrow exit universe strain a model built for faster cycles. Private equity is better suited to scaling companies that have already proven their technology and secured initial contracts, but PE faces its own constraints. Many LP mandates still reflect the old ESG consensus; fund structures attract additional scrutiny when the underlying assets are defence-related; and return profiles don’t always map onto the capital-intensive, long-cycle nature of defence investment.

New structures are emerging: longer-dated vehicles, hybrid models that blend early-stage and growth capital, and funds designed explicitly for defence economics rather than adapted from commercial tech. The managers building those structures are now positioning themselves ahead of a capital flow that is already building, but they need to work through fund terms, LP eligibility, and regulatory pathways before the raise, not during it.

Every Country Is a Different Market

Europe isn’t a single defence market. France, Germany, and the UK — the continent’s three largest — each operate under fundamentally different rules, shaped by distinct historical, constitutional, and political conditions.

France’s industrial model keeps the state close to strategically sensitive companies: Foreign investment in dual-use or defence-adjacent businesses routinely triggers prior approval requirements under France’s foreign investment screening regime, and ownership structures that pass scrutiny elsewhere may not pass in France. Germany’s procurement culture prioritises deliberation; its constitutional framework was only recently amended to accommodate the scale of spending now required, and the institutional infrastructure to deploy capital rapidly is still developing. The UK, outside the EU since Brexit, operates under its own National Security and Investment Act 2021 screening regime, procurement rules, and LP landscape.

A fund or company with Pan-European ambitions faces not one regulatory environment but many — and the complexity compounds with each market it enters. Legal structure, ownership design, regulatory approvals, and investor composition all need to be configured for each jurisdiction. What passes scrutiny in one market may be disqualifying in another.

But navigating complexity, once learned, becomes a structural advantage. The firms that do the work now — jurisdiction by jurisdiction, deal by deal — will be the hardest to displace when the market matures. 

Defence Deals Have a Different Commercial Logic

In commercial technology, the cap table is primarily a financial document. In defence, it’s also a regulatory one. That has important implications for how investments are structured, how due diligence is conducted, and how exits are planned.

Who owns the company matters in ways it doesn’t in commercial tech. A direct investor with the wrong affiliations — a foreign strategic with problematic ties, a co-investor from a sensitive jurisdiction — can complicate or block a government contract, trigger regulatory review, or compromise a security clearance. Ownership structures need to be designed with these implications in mind from the outset.

Due diligence runs differently too. Classification constraints limit what deal teams can access. And evaluating whether a company can actually win and sustain government contracts — navigating acquisition cycles, engaging the right programme offices, moving from prototype to programme of record — requires procurement familiarity that most commercial deal teams don’t have. Technical merit is necessary but not sufficient.

Exit requires planning from the outset. The acquirer universe is concentrated, transactions involving sensitive technology attract regulatory scrutiny, and European public markets remain thin for defence tech. Investors that don’t think about exit at entry will find their options limited when the time comes.

The deals that work share one characteristic: Legal and regulatory structures are built into the investment thesis from the beginning, not treated as downstream problems. In defence, structure isn’t an afterthought. It’s the work — and it requires counsel who understand both the financial and the national security dimensions from day one.

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The structural realities described here aren’t permanent. ESG frameworks are being rewritten, banking compliance is catching up with policy, and new fund structures are emerging. But the architecture will not catch up with the ambition automatically — it will catch up because practitioners build the transactions, fund structures, and regulatory strategies that move it forward. The firms that develop that fluency now, before the market fully matures, will be the ones that shape it.