The convergence of geopolitical tensions in Europe and further afield, heightened national security threats, and increasingly complex military and security operations has set the stage for private capital to deploy funds into companies that develop defence, security, and resilience technology. If these factors were not already apparent, the Prime Minister's pledge to increase defence spending to 2.5% of GDP by April 2027, alongside the Government's ambition to establish the UK as a "defence industrial superpower," certainly underscores the point. This commitment highlights the strategic importance of bolstering the nation's defence capabilities and the potential opportunities for investors in this sector.
However, venture capital and private equity are not currently perfectly positioned to capitalise on this burgeoning market. The tension arises from a perceived fundamental incompatibility between, on the one hand, fund managers' commitment to ESG investment and, on the other, defence investments. Venture capital funds often utilise ESG exclusion lists to screen out investments in companies, industries or sectors that do not align with their ethical, environmental or social values. For a long time, defence technologies have sat on those lists, largely due to concerns about the ethical or legal implications of investing in military-related activities. The evolving geopolitical landscape and discussions around the role of the defence sector demand scrutiny of this position. Indeed, as John Healey became the first Defence Secretary to close the day's trading at the London Stock Exchange, he told the gathering of business leaders, military personnel and private financiers that it was time to call an end to the prejudice against defence investment and outlined how defence is boosting the UK economy, adding significant weight to the case in favour of increasing the amount of private capital flowing into defence technology startups and scaleups.
An important misconception to address is the perceived incompatibility of defence investments with ethical or sustainable investment principles. The rigidity stems from broad exclusions targeting entire sectors. However, defence investments require a more nuanced approach. Companies engaged in developing defensive technology or innovations to counter increasingly sophisticated and overtly hostile adversaries play a crucial role in maintaining national and global security. The contention that supporting such companies is inherently at odds with ethical or sustainable investment ideals feels implausible. A more discerning evaluation of individual companies and their contributions to security and resilience could align defence investments with ESG principles, fostering a more balanced perspective. Removing this indiscriminate barrier to entry for fund managers would be a welcome development; but is it possible to move the dial further?
In March of this year, more than 100 Labour MPs and peers signed an open letter to British banks and fund managers urging them to class defence investments as ethical in a bid to boost support for Ukraine. The inference was thinly veiled: investment into defence technologies can be positively ethical. Whilst this particular plea was clearly in relation to the conflict in Ukraine, a logical extension of this message is that advancing technologies and facilitating innovations that enhance global stability and uphold national sovereignty and the rule of law can indeed be ethical; in fact, it is clear that without the luxury of a stable and secure market, which is enabled by a resilient national security posture, fund managers would not be in a position to invest at all. The rationale here seems relatively sensible, and it would be intriguing to explore further connections between the capabilities of defence technology and other ESG ideals, particularly sustainability.
We will be exploring these issues, and how to unlock capital in the defence sector in more detail at our upcoming event, "Financing Defence", held in partnership with ADS and Morphose Capital Partners on 27 May. If you are a fund or an investor looking to invest in the defence technology sector or a company raising capital, please click here to request an invite.