4. Funding and capital requirements
Market perspective
The capital base for UK defense technology remains heavily domestic, but the cross-border picture is evolving quickly, and European, Middle Eastern, APAC and US investors are increasingly paying a lot of attention. For businesses navigating those flows, the regulatory environment is now the single most important factor shaping fundraising decisions. Getting the foreign investment screening and approvals piece right early in the process—before term sheets are signed—is becoming as important to a successful raise as the commercial terms themselves. The businesses that build regulatory readiness into their fundraising strategy from the outset will move faster and attract better terms.
Scaling defense technology companies is expensive business and burn rates tend to be very high, as companies may be required to rapidly develop products or scale production in order to deliver on their contractual commitments to governments and other customers, for example. It is no surprise that almost all of the surveyed companies (97 percent) reported that they were likely to raise “significant” external funding over the next 12 months in order to accelerate growth. Not a single start-up or early-stage company we spoke to said they were not likely to raise funds.
Companies look to be considering blended finance solutions, with 49 percent of respondents looking to raise equity finance in the next 12 months, 47 percent looking to raise debt finance and 39 percent looking to make use of government grants. The combination of a mature VC ecosystem, ready access to global money markets and a supportive government makes the UK a fantastic place for any capital needs, so we are not surprised to see companies intending to make use of the various capital sources on offer.
Interestingly, government-backed investors are seen as the most attractive source of equity finance, narrowly followed by corporate venture investors, strategic corporate investors and private equity firms. There are various reasons that this might be, but it may be that this profile of investor is better placed to integrate defense technology products with their existing investments or product ranges, unlocking greater growth potential than conventional venture capital investors or family offices, for instance.
For private and venture capital, defense technology now represents a compelling investment proposition with growing government budgets, long-term contract visibility, recurring revenues, high barriers to entry and demand patterns partly independent of broader economic cyclical trends. Further, the hesitancy that once caused some funds to avoid the sector has softened, and the positive social externalities of defense technology with dual-use applications have come more sharply into focus.
There is an interesting dynamic borne through the data however, that while defense technology companies appear very favorably disposed to taking on growth investment from corporate venture investors and strategic corporate investors, when it comes to considering their preferred exit route, private equity remains the most alluring.
Favored debt solutions are similarly varied, with companies reporting a preference for blended financing through a combination of convertible debt, venture debt, commercial paper, direct lending, banks and government-backed lending schemes.
UK and European investors remain the predominant sources of capital for these companies, with the number of businesses expecting investment from UK sources alone outstripping investment from APAC, the US and the Middle East combined. That said, we are seeing a marked increase in interest among overseas investors from the UK’s strategic partners, and it is increasingly common to see them represented in funding rounds.
97% plan to raise significant external funding in the next 12 months
