Defence start-ups face a financing wall

European defence start-ups continue to face difficulties accessing capital.

Several sources in recent months have highlighted persistent challenges for start-ups and SMEs seeking financing for production expansion and technology development - a constraint that is slowing the growth of Europe’s defence industrial base and broader rearmament efforts.

- There are several elements to this, says economist Jacob Funk Kirkegaard, senior fellow at Bruegel and non-resident senior fellow at the Peterson Institute for International Economics in Washington.

- There is a general shortage of risk capital in Europe. We have a traditionally bank-oriented financial system, and it can be difficult to secure financing for, for example, a major expansion in production.

Lack the appetite

Several analyses support this assessment.

In an April op-ed, Christopher Collins, fellow at the Cascade Institute, argued that European commercial banks, after years of ESG-driven retreat from the defence sector, "lack both the appetite and the internal expertise to lend to these firms without guarantees".

At the Royal United Services Institute (RUSI), research fellow Linus Terhorst has argued that some banks impose significant reporting requirements on defence companies to comply with international banking standards and mitigate reputational risks.

Sandra Golbreich, partner at BSV Ventures, also sees a huge problem.

- The scoring systems used by financial institutions - primarily on the risk assessment side - and the financial products they offer are very outdated and do not match the needs of start-up customers, she says.

Based in Vilnius, BSV ventures invests in technology start-ups, with around half of its portfolio focused on defence.

- Banks are still using traditional criteria when assessing companies, such as cash flow, projected revenue and balance sheets. But defence start-ups are very different from traditional businesses, she said, pointing to long-term contracts and a customer base often limited to one or a few state buyers.

- In our experience, the chance of a defence start-up obtaining a bank loan is about 10 percent, Golbreich adds.

Tiina Laisi-Puheloinen is chief executive of FiBAN, the Finnish Business Angels Network. She says the overall situation has improved compared with previous years.

- Feedback from startups suggests there are still notable differences between banks in how they approach the defence sector, with some clearly more defence-friendly than others, Laisi-Puheloinen says.

She stresses that she would welcome more investors in the sector.

- The goal is to ensure that promising defence and dual-use companies are not held back by a lack of financing, she says.

Additional challenges

Kirkegaard points to two additional challenges specific to the defence sector.

For many years, parts of the financial sector have been reluctant to invest in defence companies, viewing the industry alongside sectors such as tobacco and oil.

- This remains an issue, Kirkegaard says.

- For example, if you look at the European Investment Bank, which one might expect to support the EU’s strategic priorities such as rearmament, it has been reluctant to do so. This is quite remarkable. There is a persistent sectoral stigma.

However, Kirkegaard argues that the largest obstacle lies elsewhere. 

For defence start-ups, the first customer is typically a national armed force, making procurement structures and budget allocation critical to long-term growth prospects.

- There is a tendency to choose the safer option of working with larger, established companies that are already known to the authorities. This can make it exceedingly difficult for new entrants, he says.

There has been some improvement, he adds, alongside a significant learning process within Nordic defence ministries, driven partly by developments in drones and other technologies where established defence primes do not hold a monopoly.

- However, a certain share of procurement funding should be allocated to SMEs to ensure innovation and diversify risk. A calculated risk must sometimes be taken, with funding directed towards the sector.