Private equity's role in the defense industry has shown remarkable growth. Venture capital deal values have multiplied 18 times in the last decade, growing faster than any other industrial sector. Defense and dual-use companies now attract nearly $100 billion in private capital each year. This investment boom comes when governments worldwide are boosting their defense budgets to build stronger industrial capabilities.
Investors find dual-use technologies appealing as they connect commercial uses with military requirements. Government programs actively support this flow of private money into defense. The U.S. Air Force's AFWERX program shows this success by using $332 million in private capital alongside $606 million in government funds within a year. German authorities have placed large defense procurement orders, which makes defense assets more attractive to private equity aerospace and defense firms. The combination of more funding, government backing, and tech crossover has revolutionized an industry that public investment once dominated.
Private Capital’s Expanding Role in Defense Innovation
Defense budgets worldwide remain tight even as security threats grow. This contradiction creates a gap where traditional defense procurement doesn't deal very well with faster evolving technologies and security needs. Defense Research, Development, Testing, and Evaluation (RDT&E) budgets stayed flat between 2010 and 2020. Commercial technology state-of-the-art grew exponentially during this period.
Defense budget constraints and the innovation gap
Government defense budgets work within strict procurement frameworks that lead to long development timelines. Major defense acquisition programs take 7-10 years from concept to deployment. This timeline doesn't match the speed of modern technological change. The technology might become outdated by the time systems reach the field.
Commercial sector companies develop products in months, not years. This creates a stark contrast with the slow procurement cycle. Defense contractors typically focus on meeting specific military requirements instead of pushing technological boundaries. This approach has widened the innovation gap, especially when you have emerging fields like artificial intelligence, autonomous systems, and advanced manufacturing.
Private equity aerospace and defense trends since 2020
Private equity investment in aerospace and defense has grown since 2020. The sector received more than $225 billion in private equity funding between 2020 and 2023. This unprecedented interest shows a radical alteration in defense innovation's financing and development.
Several key trends have emerged:
Increased deal activity: Private equity firms completed over 240 defense technology acquisitions in 2021-2022, double the rate from previous years.
Focus on dual-use technologies: Nearly 60% of private equity defense investments target companies that develop technologies for both military and commercial use.
Strategic consolidation: Private equity firms build defense technology platforms through strategic collaborations of complementary capabilities.
The COVID-19 pandemic sped up this trend instead of slowing it down. Investors looked for reliable returns as traditional sectors faced uncertainty. Defense spending's stability created new defense technology ecosystems that work alongside traditional prime contractors.
Why private capital is critical for dual-use innovation
Private capital plays a crucial role in defense innovation, particularly with dual-use technologies. These technologies benefit from commercial market dynamics that speed up iteration and reduce costs, unlike traditional defense-only systems. Private investors bring both funding and expertise to scale commercial technologies.
This capital helps bridge the "valley of death" in defense innovation - the gap between basic research funding and program-of-record status. Private equity and venture firms provide patient capital that lines up with longer defense development cycles.
Private investment helps defense-oriented startups direct through complex procurement rules. Experienced investors know about government contracting, compliance requirements, and security protocols. They help innovative commercial companies work better with defense customers by bridging cultural and procedural gaps.
The most successful private equity defense investments target companies serving both defense and commercial markets. This approach reduces customer concentration risk and lets technologies benefit from commercial scale economics.
Dual-Use Technologies as a Strategic Investment Bridge
"Governments are seeking dual-use technologies that can serve both military and civilian applications, further fueling private market investment." — David Crouch, CEO at Decorus Imperium, defense tech private equity fund
The term "dual-use" came from post-WWII talks about nuclear materials that could work for both military weapons and civilian energy. This concept has grown into one of the most important strategic investment chances in today's private equity defense industry.
Definition and scope of dual-use technologies
Dual-use technologies cover products, processes, and breakthroughs that serve both commercial markets and defense needs. Political and export control contexts define these items as goods, software, and technology that work in civilian and military applications. Dual-use works better as a strategy than just a category. It needs careful plans, priorities, and trade-offs to direct decisions on product development, market positioning, and funding approaches.
These technologies show up in almost every field - artificial intelligence, advanced materials, nanotechnology, cybersecurity tools, satellite technologies, biotechnologies, quantum computing, aerospace, and unmanned systems. Private capital finds many ways to fund defense innovation through this wide range of options.
Examples: AI, drones, and space sensors with dual applications
AI stands out as the most significant dual-use technology. It improves both commercial efficiency and military effectiveness. Medical diagnostic AI systems built for civilian use can help assess battlefield casualties too.
Drone technology shows another strong dual-use case. Companies that started with commercial drones now work in defense markets. Technology now flows both ways. Military tech used to move down to commercial uses, but today's breakthroughs often start in commerce and move to defense. U.S. companies lead the dual-use drone market - AeroVironment, Insitu, and Anduril hold the top three spots.
Space-based systems, especially satellite sensor networks, make up another significant area. Commercial space expertise fits defense needs perfectly, and the same technology often serves both markets. This creates what experts call a "double dual-use dilemma" - private space companies can become military assets while running commercial operations.
Commercial-to-defense transition pathways
Companies move from commercial to defense work through several proven routes. Technology Transfer (T2) agreements let companies license Department of Defense lab inventions for new products. The U.S. Department of Defense's 35,000 scientists and engineers create about 600 patented inventions yearly across all technology fields.
Cooperative Research and Development Agreements (CRADAs) provide another path. They allow defense entities and private companies to work together. Both methods have successfully turned technologies into dual-use products that support military missions.
Europe promotes a "dual-use by design" strategy. This approach builds dual-use thinking into technology development from day one. NATO's Innovation Fund supports this ecosystem by giving risk capital to deep-tech startups that work on Alliance defense and security challenges.
Private equity investors who understand these transition paths can spot companies ready to succeed in both commercial and defense markets. These companies often deliver better returns through diverse revenue streams and lower market concentration risk.
Government Demand Signals and Incentive Structures
Government incentive structures send vital signals to the private equity defense industry. These signals create investment paths for innovative defense technologies and help new contractors enter the market more easily.
Fixed-price contracts and OTAs in defense procurement
Fixed-price contracts are the life-blood of defense procurement. They put most risk and cost responsibility on contractors while giving them strong reasons to keep expenses in check. The contracts set firm prices that don't change based on performance costs, which means less paperwork for government agencies. The Department of Defense dropped its fixed-price contract preference in 2024, but these tools still revolutionize procurement by giving budget certainty to government buyers.
Other Transaction Authority (OTA) deals have become more popular, with billions in annual spending. OTAs give more flexibility than regular procurement methods and focus on research, prototyping, and production. These contracts remove obstacles like cost accounting rules, which lets more non-traditional defense contractors work with the government. OTA prototype deals need to meet one of three conditions: non-traditional contractor involvement, small business participation only, or non-federal sources providing at least one-third of funding.
Catalytic capital and matching fund programs (e.g., AFWERX)
AFWERX's Strategic Funding Increase (STRATFI) and Tactical Funding Increase (TACFI) programs illustrate new ways to boost private investment. These programs want to bridge the gap between Phase II and Phase III Small Business Innovation Research (SBIR) contracts. Defense-specific projects get a 1:2 matching ratio - the Department of Defense puts in two dollars for every SBIR dollar. Dual-use technologies get a 1:1:2 ratio that adds private capital to the mix.
SpaceWERX invested $72 million in these matching programs in 2024. This investment grew to over $125 million across 14 technology programs. TACFI gives smaller support between $375,000 and $1.9 million for up to 24 months. STRATFI offers $3-15 million over 48 months.
Long-term purchase commitments and aggregated demand
Multiyear procurement contracts work as strong demand signals that reduce costs and stabilize the buying process. Contractors can save money through bulk purchases and boost productivity. Annual funding is required, but long-term commitments let contractors plan ahead. This especially helps smaller suppliers join projects with high startup costs.
Combining equipment orders from multiple customers gives industry clear requirements. NATO's Defense Production Action Plan emphasizes this approach. Markets understand exactly what defense agencies need and invest in long-term production. The result brings cost savings through scale and improves allied forces' ability to work together.
Private Equity Entry Points in the Defense Value Chain
Private equity firms see the defense supply chain as a goldmine for smart investments. S&P Global Market Intelligence data shows private equity- and venture capital-backed investments in aerospace and defense reached $4.27 billion globally in the first quarter of 2025. This amount nearly matches the $4.31 billion invested throughout 2024.
Tier 2 and Tier 3 suppliers as acquisition targets
Middle-tier suppliers stand out as attractive acquisition targets within the aerospace and defense ecosystem. These companies have specialized capabilities and operate at scales where operational improvements can deliver substantial returns. The aerospace supply chain complexity is staggering—a typical US commercial aerospace original equipment manufacturer depends on more than 200 tier 1 suppliers and roughly 12,000 tier 2 or tier 3 suppliers.
Defense firms now prefer regional production over global supply chains. This move has created more acquisition opportunities among middle-tier suppliers. These smaller enterprises bring specialized manufacturing capabilities with high barriers to entry and strong intellectual property. Such characteristics help maintain stable cash flow and growth potential under private equity ownership.
Private equity defense tech case studies: BlueHalo, Quantic
BlueHalo showcases a winning private equity strategy in defense technology. The company built capabilities faster in space technologies, counter-uncrewed aircraft systems, and electronic warfare through strategic acquisitions. This platform-building approach led to BlueHalo's $4.1 billion acquisition by AeroVironment in 2024. The combined entity should deliver more than $1.7 billion in revenue.
Launched in 2021, Quantic Electronics is a consolidation platform for specialized electronic component manufacturers in defense applications. Quantic has grown through nine acquisitions. The company now owns businesses with complementary capabilities in RF/microwave components, sensors, and other mission-critical electronics.
Operational improvements and scale-up opportunities
Private equity investors can tap into substantial value through operational enhancements. Products spend over 90% of their time idle on factory floors in typical aerospace and defense manufacturing environments. Companies can boost throughput by 50-150% by streamlining these operations without affecting safety or quality.
Defense technology investments work best with companies that serve both defense and commercial markets. This strategy reduces customer concentration risk and lets technologies benefit from commercial scale economics. The dual-market approach helps newer defense technology companies overcome scaling challenges in manufacturing capabilities, supply chain resilience, and technical talent acquisition.
Overcoming Barriers: Risk, Scale, and Go-to-Market Challenges
The private equity defense industry faces major obstacles despite its growth potential. These challenges need innovative approaches to ensure successful investments and eco-friendly operations.
Navigating the 'valley of death' in defense tech
Defense tech startups often hit the notorious "valley of death"—a gap between original funding and revenue sustainability. The past decade shows only 16% of Department of Defense Small Business Innovation Research (SBIR) companies won Phase III transition contracts. Many successful SBIR recipients generate more Phase I/II funding than they receive in Phase III revenue, which results in negative investment returns. This funding gap forces promising technologies into dormancy before production begins.
Customer concentration and program dependency risks
Defense-oriented firms face extreme customer concentration risk. The Department of Defense procurement system channels over 70% of major contract value to approximately ten companies. Small defense contractors rely heavily on a single government program or agency, which makes them vulnerable to budget changes or program cancelations. This dependency becomes riskier as the defense industry has turned into one of the most indebted sectors, with more than 1,500 contractors bought through leveraged buyouts in two decades.
Strategies for scaling dual-use startups to production
Defense tech companies that succeed use several key strategies:
Dual-use focus: Companies that develop technologies for both defense and commercial applications can build scale in commercial markets while pursuing longer-term defense contracts.
Vertical integration: Defense customers prefer complete systems over standalone software, so providing integrated hardware-software solutions works better.
Mutually beneficial alliances: Working with established defense contractors as partners makes market entry easier by providing access to installed bases and customer relationships.
Companies that resolve program-centric defense models with product-centric commercial approaches achieve better success in scaling operations.
Conclusion
Private equity investment acts as a revolutionary force that has altered the map of defense technology - an industry where government funding once ruled supreme. Our analysis shows how private capital fills crucial breakthrough gaps while dual-use technologies build bridges between commercial and military applications. Defense budgets remain constrained despite growing global threats, which creates perfect conditions for private investors who contribute both funding and commercial expertise.
Dual-use technologies emerge as highly appealing investment targets. These technologies cater to commercial markets and defense requirements at once. This reduces customer concentration risk and enables valuable cross-sector breakthroughs. Companies that develop capabilities in artificial intelligence, unmanned systems, and space technologies show how this approach creates value through diverse revenue streams.
Government programs spark private investment through creative mechanisms. AFWERX programs utilize matching funds to extend public dollars, while OTAs lower barriers for non-traditional contractors. These indicators give investors confidence about long-term market potential and regulatory backing.
Defense supply chain provides multiple entry points for private equity, especially among tier 2 and tier 3 suppliers. BlueHalo and Quantic serve as examples of how consolidation builds platforms with complementary capabilities that lead to substantial returns through scale and operational improvements.
Substantial hurdles still exist in this space. The "valley of death" between original funding and sustainable revenue threatens promising technologies. Customer concentration and program dependency create risks that need careful handling. Companies that use dual-use strategies, vertical integration, and mutually beneficial alliances can traverse these obstacles well.
Global security concerns continue to grow, and private equity will without doubt play a bigger role in defense breakthroughs. This joining of private capital, dual-use technologies, and government support builds a powerful ecosystem that tackles emerging threats while generating attractive returns. The future defense world will rely more on this symbiotic relationship between public and private capital—each making the other stronger toward common security goals.
FAQs
Q1. What are dual-use technologies in the defense industry? Dual-use technologies are innovations that can be applied to both commercial markets and military needs. They include areas like artificial intelligence, drones, and space sensors, which can serve civilian purposes while also meeting defense requirements.
Q2. How is private equity changing the defense technology landscape? Private equity is playing an increasingly important role in defense innovation by providing funding and expertise for dual-use technologies. This investment surge is helping to bridge the gap between commercial innovation and military needs, accelerating the development of cutting-edge defense capabilities.
Q3. What are some challenges faced by defense tech startups? Defense tech startups often struggle with the "valley of death" - the gap between initial funding and sustainable revenue. They also face customer concentration risks, as they may depend heavily on a single government program or agency. Scaling production and navigating complex procurement processes are additional hurdles.
Q4. How are governments encouraging private investment in defense tech? Governments are using various incentive structures to encourage private investment, such as fixed-price contracts, Other Transaction Authority (OTA) acquisitions, and matching fund programs like AFWERX. These initiatives aim to reduce barriers for non-traditional contractors and catalyze private capital in defense innovation.
Q5. What strategies can defense tech companies use to overcome scaling challenges? Successful defense tech companies often focus on dual-use technologies to serve both commercial and military markets, reducing risk. They may also pursue vertical integration to provide complete solutions, and form strategic partnerships with established defense contractors to facilitate market entry and access customer relationships.