'Without the S, we don’t have ESG': The impact investors going into defence tech (and those staying out of it)

The debate over whether impact and other VCs should enter the defence space encompasses a lot of elements. On the one hand, there are concerns over the ethics of investing in companies and funds involved in what is perceived as the 'arms trade.'

On the other hand, there are myriad ‘dual-use’ technologies and projects that, while they may benefit Europe’s defence footing, can also be used for civil and environmental benefit.

At the same time, the concept of 'resilience' is being re-examined. When we talk about sustainability, preserving and conserving land and civilisation for future generations, how much does defence play into that? Or is 'defence tech' a distraction from, perhaps even counterproductive to, the pressing need for an environmental transition?

Is 'defence tech' a distraction from the pressing need for an environmental transition?

Defence tech is growing

There are no data on how much impact venture capital is being diverted into defence tech. Nonetheless, investors and advisers Impact Loop have spoken to tell us that it’s an active discussion, and there are some funds in the works for hundreds of millions of euros.

One investor, Catharina Sandberg, CEO of the Swedish business incubator Lead, explains the perspective had begun to shift long before the massive ReArm Europe funding announcement from the European Commission. It started, she says, with dual-use tech.

"Previously, we were looking at things through sustainability lenses in the incubator. Now we’re also using dual-use lenses," says Sandberg.

Since last year, Lead has been running a programme for dual-use companies, working with the Swedish Armed Forces. One of the startups in the incubator is focused on medical visualisation to train trauma teams in field situations.

"The companies participating have all explored a civilian market with a civilian application," says Sandberg. "What they all have in common is that they are aiming to secure the Swedish Armed Forces as a future customer."

Think about defence all day

Around Europe, a closer look at the portfolios of impact and impact-adjacent VCs shows many dual-use plays, and some impact-minded investors are explicit in their desire to back Europe’s defence infrastructure.

One such investor is Sten Tamkivi, a tech veteran and partner with investment platform Plural, based in Estonia, "right on NATO’s eastern flank" as he says.

"Philosophically, we Estonians think about how to defend the country every day, so I’m seeing people embrace the recognition by various European governments that we urgently need to build up our defence capabilities," Tamkivi tells Impact Loop. "Entrepreneurs don't wring hands and complain, they build. It is our job as societies, and investors specifically, to give them the means, capital and the support for solving the biggest issues of our time."

Add security to sustainability?

In the broader European institutional investment landscape, there are many people now looking for opportunities in defence, says Christian Andersson, founder and partner with Worthwhile Capital Partners, an investment advisory based in Stockholm.

He says after a long period of defence being essentially ruled out, there is a growing awareness of the need to add security to other sustainability concerns, what he describes as 'SESG' (where "S" stands for "security").

"Without the S, we don’t have ESG," he tells Impact Loop.

There are of course still lines that most, if not all, are unwilling to cross. These include chemical and biochemical weapons. And the issue of nuclear deterrence build-up is dividing investment communities.

On the other side, Andersson says there is a lot more interest in investing in arms and ammunitions manufacturers. One example of that in recent months is the growing call in Norway for the country’s massive sovereign wealth fund to lift its ban on weapons investments.

Needs government support

Christian Andersson says this growing interest needs to be met by more proactive managers looking to craft defence plays – something he is actively on the lookout for – as well as government support in terms of seed funding and de-risking to better guarantee returns and entice more institutionals in.

"Those models exist," he says, "and I think some investors, at least in private markets, expect the government to pitch in."

He also says there needs to be a re-think in terms of the capital structures for such investments, arguing that for instance debt – in the form of say EU defence bonds – could allay the nerves of more conservative investors.

One concern about all of this from an environmental impact perspective is how much Europe’s military build-up may deepen its carbon footprint. The European Commission has expressed its intention to make sure new investments go into cleaner defence technologies, and changes to procurement across the continent are said to be designed to reduce duplication.

At the same time, Andersson says he thinks new investments along these lines could have a J-curve effect, with an initial carbon outlay followed by rapid decarbonisation.

I think some investors, at least in private markets, expect the government to pitch in

Not seeing more dealflow

Although there is a lot of buzz around defence tech in Europe, even among more singular-focused impact companies, by far not all players are shifting strategies.

"For us, we won't be affected by that, to be honest, because we continue to focus on what we know,” says Alessandro Zaccaria, partner with pan-European VC 360 Capital.

While not solely impact-focussed, 360 Capital counts climate-tech and deeptech as two of its three verticals, with hundreds of millions going into climate-tech in particular.

They do have a few dual-use plays that could theoretically be used in military applications, such as maritime surveillance startup Unseenlabs, autonomous driving services lab Arbe and LiDAR sensor provider Innoviz. They also exited a defence tech company last year, when Preligens, focussed on artificial intelligence for aerospace and defence, sold to Safran.

Zaccaria observes there's a lot of hype in the investment community about pivoting more to defence tech. While he and his firm are clearly not against investments in the sector, given the portfolio highlights above, he says that for 360 Capital the commercial incentives just aren’t strong enough to be swayed from their main focus.

On the one hand, he says, while there is a lot of new announcements in terms of fundraising, he’s not seeing much on the actual dealflow side. Further, defence plays can be tricky to exit, as there is a very limited pool of potential buyers, given national security restrictions.

It's these financial considerations, as well as a desire to remain focussed on what they know, that keep 360 Capital looking for opportunities within their own verticals, without fully discounting dual-use and defence.

"Our investment thesis is very clear, you know?" says Zaccaria.

Doesn't see any contradiction

Back in Tallinn, Sten Tamkivi says he and his investment platform Plural are clear on the need to marshal private capital to back European defence. He says he doesn’t see any contradiction between environmental and defence ambitions.

"Both energy and defence are critical areas with big problems for us to solve,” he said. "We have extraordinarily capable, driven and ambitious founders working on these issues, whether that’s Proxima Fusion for abundant clean energy or Helsing for defending our democracies. We need founders across all these sectors to transform our world, boost European GDP and strengthen the continent’s sovereignty."

(Image from left: Sten Tamkivi, Catharina Sandberg, Alessandro Zaccaria and Christian Andersson)