Toby McCrindle, Partner, Mishcon
I'm delighted to welcome, uh, Nicholas Nelson today in the next, um, iteration of our series of videos on the future of defence. Um, Nick is the GP at a specialist defence fund called Archangel, um, and has been investing in defence for close to two decades and is perhaps the original defence investor, should we say. Um, so before we dive into what we're going to talk about today, I think if Nick, Nick, if you could just give us a little, uh, history into how you got into defence investing and then what you've done in the last couple of decades in this space.
Nicholas Nelson, General Partner, Archangel
That's great. Thank you, Toby, for having me and always happy to have the conversation. So as you said, I've been in defence for the last 2 decades. I've had the luxury, some may say, in my life of spending half my life in Europe and half in North America. So I've gotten to see both sides of it in defence and aerospace contexts throughout the whole value chain. So I started my career over here in London, primarily working with governments as well as large aerospace and defence companies as a consultant, as many do when they're not sure what they want to do after uni. Uh, on the basis of that, I went to go serve in government supporting various, uh, defence functions, predominantly working downrange as well as from headquarters with special operations forces on the counter-terrorism mission. What really was foundational for me and what led me to where I am today was towards the end of that, I got to do a rotation back at headquarters working on emerging technologies at the time. And so on the basis of that, I went back, uh, and did my MBA at the Tuck School of Business at Dartmouth in the United States. And that's when I really started engaging with the startup ecosystem on campus through our Entrepreneurship Centre and started advising and very innocently eventually investing very small cheques to start into defence tech startups.
Toby McCrindle, Partner, Mishcon
What makes Archangel stand out amongst what is now a very large kind of stable or pool of so-called defence investors or people that are angling towards defence? So obviously you are the, you know, one of the, and your partners are absolutely key to that, but what particularly stands the fund apart from others?
Nicholas Nelson, General Partner, Archangel
Yeah, I think there's a few different things. The first thing I'd highlight is, I mean, this is, this is not reinventing the wheel, this is all not net new. We have a number of analogies there and when we look at that, you have the US defence tech market, which really dates a little earlier from around 2015, 2016. Uh, and then you also have the new space ecosystem, though one hates the parlance, that sprung up around originally things like SpaceX and Blue Origin, but now is obviously run its course to a large extent, both in Europe and the United States. So there are things that inform this market. The difference is similar to most deep tech, if you will. I think you really need 3 things to succeed, to actually be a credible defence investor. First and foremost, I do believe you need subject matter expertise or domain expertise, if you will and as I've spent 20 years of my career only doing defence, uh, we really bring that to the party, so to speak. The second is because of the nature of obviously deep tech, but especially defence tech, you need to have the technical acumen and so coming from an engineering background and actually really understanding how the technology works, how it integrates into larger systems, but then also how you can help founders prioritise and do their tech road mapping. I'm really lucky enough to be partnered with my co-GP, Dr Daniel Karoo, PhD himself out of Bristol, but who's been doing this on the venture side, first in space, then in dual-use and defence tech now for over 11 years. And so that's really what we bring together. The last thing, and this is the really crucial bit I think that plugs in, that's really lacking in the market, is the institutional credibility. Now, both Daniel and myself have been investing for a long time, both, you know, a decade each, or in his case, well over a decade and we have those credible track records. And that's what we bring together, it's that subject matter domain expertise in defence and first-hand experience. It's that technical credibility and technical expertise and it's also that track record and indeed that institutional backing that de-risks it for LPs. If you are missing any of those three things, I think it makes you less credible to actually do defence in the market.
Toby McCrindle, Partner, Mishcon
So last year was a big year for defence investing. Globally, we're heading to $30 billion of investments into defence, which is an enormous number and I don't know what the multiple on that is from when you first started globally, but it's going to be huge. Um, but that has created a bubble, at least I think we're in a bubble, um, and I think probably a lot of people would agree. Is that, I mean, is the level of investment flowing into defence technology now a good thing from a capabilities perspective? So do you think there is a material in increase in access to capability across Western NATO, NATO more broadly, as a result of all the capital flowing in? Or is it just heating up a bubble that's actually not resulting in anything useful, and therefore people are going to lose out?
Nicholas Nelson, General Partner, Archangel
I think it's a really great question, one I've discussed a lot and thought about a lot. Um, so the first thing I'd say is I don't believe we're in a bubble, actually.
Toby McCrindle, Partner, Mishcon
Okay.
Nicholas Nelson, General Partner, Archangel
I do believe we are in a hype cycle, and those are fundamentally different things.
Toby McCrindle, Partner, Mishcon
Okay.
Nicholas Nelson, General Partner, Archangel
A bubble presupposes, at least in my mind, that this at some point is going to pop, and then we're going to see a complete kind of washout of a given industry or a heavy washout of an industry or vertical. I don't think that's going to happen in defence. With that said, I do believe we are in a hype cycle where you have a lot of fast followers or defence curious investors coming in who don't always know what they're doing, which has to a certain extent, and because that hype driven valuations up in some cases, especially I would say later early stage, if you will. So your Series A, your Series B valuations, and in some cases your inception startups that happen to have some flashy names associated to unsustainable valuations. With that said, if you do have that expertise that like I believe we do in that value proposition, we've been able to still find good value in the market and working with capabilities and founders who are delivering real capabilities on the battlefield. There is a big difference between taking advantage of a hype cycle like some companies are and actually net-net delivering a new capability to the battle space and that's what's been lacking. And I think we've seen that in Ukraine where some of the flashier names, both in Europe and indeed in the United States, have not performed as well or outright failed or even been absent from the battle space and I think that's the clear distinction. We are proud that most of the companies in our portfolio are battle-proven in Ukraine already, as well as further field in other geographies where there is instability. .
Toby McCrindle, Partner, Mishcon
Yeah. And so…
Nicholas Nelson, General Partner, Archangel
But do I, sorry to answer your second question, if I may interrupt. Do I believe that there has been net new capabilities developed to the battlefield as a result of this? Yes. Do I believe that always comes from the biggest and flashiest names? Absolutely not.
Toby McCrindle, Partner, Mishcon
Yeah and, and do you think there is a, and I suppose the answer is no, but do you think there's a correlation between the massive influx of capital and those capabilities being developed, or because of the special circumstances around Ukraine, that innovation would have happened by necessity anyway, regardless of the big cheques floating around in, you know, mainstream investing?
Nicholas Nelson, General Partner, Archangel
So I, I think we need to be careful about equating European defence tech with Ukrainian defence tech. Theirs is driven by an existential conflict, and they do have an iteration cycle, it would be hard for anyone to replicate, if ever. So that's a key advantage there and so I think a lot of those were going to be developed regardless. With that said, capital has gone into that ecosystem, not as much as perhaps should, but we can debate that later.
Toby McCrindle, Partner, Mishcon
Yeah.
Nicholas Nelson, General Partner, Archangel
That has helped accelerate some of these. Within European defence tech, I think, to use a little Henry Kissinger-ism, who do I call when I want to call Europe? You're talking about, you know, 30 different markets and each one has responded and developed things in a different manner. And I think the closer you get to the front, NATO's frontier, so its border with its main adversary in Russia, I think there's been more urgency there. As you get further away, your mileage may vary.
Toby McCrindle, Partner, Mishcon
And so on that point then, so you're focused on, as you said, um, the Baltics, Poland, UK to some extent, and, and the High North. So is that why you're focused on those areas because they are, frankly, they share long land borders with, with Russia, for example? What's the focus and where's the advantage for you there?
Nicholas Nelson, General Partner, Archangel
Yeah, so that's a great question. Why we focus on specifically, so we do, do pan-European, um, but all pan, so that's kind of one of our drivers. But the reason we focus on that region specifically is it's a sub-NATO construct called the JEF, or the Joint Expeditionary Force. We call it the JEF+ because we also include Poland in there, which is increasingly relevant for that. Why the JEF is important for us and why we really believe in, why we've backed companies throughout the region, continue to do so, as well as have kind of the deep connectivity with the militaries and governments throughout there is fundamentally because first and foremost, these tend to be the ones who, yes, are close to the frontier and do have that greater urgency and we believe that's important. As well, second, there's also a greater adherence to NATO standardisation agreements or STANAGs, and that has resulted in a greater degree in part because of STANAGs and also just because of geography, of interoperability between those countries, as well as a more regular exercising together in training environments so they're more used to working together.
Toby McCrindle, Partner, Mishcon
How then do you sift through the noise? And there is a hell of a lot of noise in the market, both investor side, you know, buy side, sell side. How do you sift through and, and then in terms of capabilities, what are you most interested in at the minute?
Nicholas Nelson, General Partner, Archangel
I think a lot of investors are going to skate to where the puck is rather than where it's going, to use a Wayne Gretzky-ism, if I will, or if I can in this case. And so we really look based on those networks and our subject matter expertise to identify gaps that already are existing or what we think are going to be important in the longer term and place our educated bets, if you will, on the basis of that.
Toby McCrindle, Partner, Mishcon
Given your, um, dual, your own dual-use status as an American and sort of British guy, what advice have you got? So we're helping some of the companies you've talked about there, but also other companies in the market to, to bridge the gap, go from Europe to US and sometimes US to UK and Europe. At what stage do you think it's sensible for a company, Kraken, a really great example, because they went to the US very quickly and have scaled really fast, or are scaling really quickly. What's, what’s your advice for founders looking at the US? What stage do you think, you know, of a company's lifecycle it's sensible to start looking at the US? You know, obviously it's an expensive play, it's fraught with risk, etcetera. What, just off the cuff, because we didn't prep for this one, but you know, what stage do you think is appropriate?
Nicholas Nelson, General Partner, Archangel
What I've found historically is that the bigger your indigenous market is, so if you're coming out of, say, France, Germany, the UK, you have a lot of work still to do in your home market. Conversely, if you're coming out of the Baltics or Finland, you have a smaller home market, so you need to be thinking almost from inception of where you're going to go next. That's not always the US market, nor should it be, because what one has to realise about the US market is, yes, it's quite massive, but if you are a foreign company, you're going to be at some of a disadvantage.
Toby McCrindle, Partner, Mishcon
Yep.
Nicholas Nelson, General Partner, Archangel
But also when you do come in, it is a knife fight. People who are much more well-capitalised than you and do have the benefit of being American already and home-based there and only focused on that market are those you'll be competing against. So you're going to have to learn some tough lessons, but also come in there with the right team, the right potential end users in mind, but also a fair bit of capital. So if you are a hardware company, that's going to be most likely manufacturing in America. Which again drives up your CapEx requirements and as such, you better be well-capitalised versus if you're a software play, that can be a different story. I think the biggest thing is to understand if you are a foreign company, I don't care if you're British, Estonian, Norwegian, what have you, you need to answer the mail in your home market first because there are a few answers you can get if and when you come to the US market. The first thing they'll do because of how much overlap there's been during the global war on terror and even now, they will go to their counterparts. They will call up the Norwegian MOD. They will call up main building here. They'll say, hey, have you heard of this company? The worst answer is no. Uh, the second worst answer is obviously yes, but we're not really working with them, or even worse, they're not good.
Toby McCrindle, Partner, Mishcon
Don't work with them.
Nicholas Nelson, General Partner, Archangel
The ideal one is no, yes, and we're actually using them because then that automatically clears you. You have to clear that hurdle to have any credibility in a new market and that's the same for the US as it would be if you're going into Australia, Singapore, or other European markets.
Toby McCrindle, Partner, Mishcon
Yeah. What else are you predicting for the year ahead from a defence tech perspective?
Nicholas Nelson, General Partner, Archangel
Yeah, I think, uh, there's going to be a lot of rubber meets the road this year. There have been a number of times, including within our portfolio, where we've seen both, uh, your traditional large aerospace companies as well as, a phrase I'm not always aligned with, but neo-primes.
Toby McCrindle, Partner, Mishcon
Yeah.
Nicholas Nelson, General Partner, Archangel
Start looking for acquisition, both in terms of getting new market access or, or and, getting new revenue access because they're being held to task by their investors. So I think you'll start to see more consolidation. The other bigger trend I think you'll see, and this will, I think, tell a lot about the destiny of European capabilities, is you'll see more private equity interest in here from a roll-up standpoint. So in the US, there's a phrase I coined years ago that was done around called H+I or heritage plus innovation. It was where you take your traditionally, you know, mom-and-pop businesses, to use US parlance. I'll butcher the German here, but the Mittelstand companies in Germany, but rolled up into an ecosystem, but paired with then your venture-backed startups. So look at something like Voyager Space, uh, Colorado, or some of the roll-ups like, um, out of A Industrial Partners in the United States, Blue Halo out of Arlington Capital Partners that was done, acquired then by AeroVironment. Where you pair these together and you had the high upside of the startups with the longer-term revenue projections of the SMEs or SMBs, depending on the nomenclature you'd like to use. I think you're going to start seeing that advent. Why I think it's going to be really critical for Europe is there's not a lot of European private equity involved right now.
Toby McCrindle, Partner, Mishcon
Yeah.
Nicholas Nelson, General Partner, Archangel
And I know US private equity is starting to get into the market. Uh, we've engaged with some of them quite a bit. And so if the European private equity does not start moving up their timeline, then I think you're going to see a lot being carved out by the United States, which is going to be good for founders and good for exits and good for early-stage investors like myself. I'm not sure it's going to be a net positive if you are sitting in Paris, Berlin, or London and you're looking forward to have sovereign capabilities.
Toby McCrindle, Partner, Mishcon
Yeah, that's a great point. We obviously can't talk names, but there are probably 3 or 4, um, vehicles getting put together at time now that we're, you know, aware of or helping with that are looking at that model. Um, or it's being stimulated in some cases by, um, founders who are looking to effectively become private equity overnight and, and raise a tonne of money from institutional investors, so, we're going to buy up these platforms, we're going to knit them together. Some are revenue-generated, some are profit-generating now, so positive EBITDA, and others they'll take a punt on and it's really interesting. I mean, that's going to be a really, really interesting, um, uh, kind of thread throughout the year, I think. Great. Well, that was fascinating, thank you. Um, you're a busy guy, so I appreciate you taking the time out, um, and perhaps we can chat at the end of the year and look back at our predictions.
Nicholas Nelson, General Partner, Archangel
Um, I think that sounds great. Thank you for having me today, Toby.
Toby McCrindle, Partner, Mishcon
Real pleasure. Thank you.