Investing in dual-use startups: A case for European tech sovereignty

Europe is too dependent on foreign tech players to have a shot at tech sovereignty. Dual-use companies that serve both civilian and military purposes could be a way forward, but investors and governments need to play along.
Investing in dual-use startups:  A case for European tech sovereignty

The first step in solving any problem is to recognise that there is one. The war against Ukraine has been a painful reminder that we in Europe are too dependent on others when it comes to defense, energy, semiconductors, or any innovative digital technology.

If Europe is to regain digital sovereignty and compete with the world’s technology superpowers–the US and China–investment in key technologies is critical, and capital should come from both investors and governments.

Given Europe’s lack of big tech players, dual-use companies could raise the region’s profile in specialised areas and help the continent stay in the game.

Dual-use can be a game-changer

The war has changed the perspective on dual-use startups, and defense-related technology investments have increased in the past year.

As the term suggests, dual-use startups focus on two sectors: Civilian and commercial services targeting businesses or consumers and applications designed for law-enforcement or military uses.

Drones are a good example; they can be used for aerial mapping and processing commercial geospatial data for agriculture, while at the same time, armies can use them for battlefield reconnaissance of enemy positions.

European investors held back by regulation and tenders

Unlike the US or China, Europe's unique model is based on shared values, where technology is developed jointly and shared between partners. So, only by working together and creating European champions in software and hardware will we gain digital sovereignty, strengthen supply chains, reduce the region’s dependency on foreign systems, protect our infrastructure, and develop new business opportunities.

The current environment provides incentives for successful long-term investment in R&D-intensive companies. The example of companies like BioNTech is a case in point.

Cross-border cooperation is common in the defense and research sectors, from which dual-use companies often emerge. Though not always starting as dual-use businesses, the core advantage of providing commercial and defense-related solutions is you can shift according to demand and tenders.

We—governments, VCs, and citizens alike—have an interest in the long-term success of European players that develop and operate key enabling technologies in cybersecurity, aerospace, and artificial intelligence. But the only way to do that is if VCs invest in dual-use startups and governments sign up as their customers.

Sounds simple enough, but in reality, it’s a chicken-and-egg problem: The governments’ silo-mentality, risk aversion, and ethical considerations hinder investment in more dual-use companies across the continent.

Dual-use reduces investment risks

Dual-use technology is highly regulated, and for good reasons. The EU has adopted a robust regulation that imposes licensing requirements and procedures on all EU member states that engage in the export, brokering, technical assistance, transit, and transfer of dual-use items.

Compared to existing DefenseTech companies, startups active in this industry typically struggle to win government tenders because of the time, networking, and money required to navigate these processes.

All this may deter investors looking for quick wins. Still, there’s a silver lining: Given their inherent agility, startups can prove a commercial product-market fit before taking the risk and applying their system to defense purposes.  

The risk/reward profile of the company and the product-market fit still have to make financial sense for the institutional VC investor, but dual-use businesses mitigate investment risks because, unlike traditional DefenseTech companies, they don’t rely solely on winning the few available large government customers.

That makes dual-use startups attractive, balancing long sales cycles and higher customer retention typical to governments with shorter commercial sales cycles and lower customer retention.

Europe needs to keep up

However, the biggest problem for any defense or dual-use startup is not a lack of government funding but of governments as customers. States still rely on “old economy” relationships and procurement systems to equip armed forces and develop new technologies.

Furthermore, we need to tackle other fundamental challenges, mainly bridging the R&D funding gap (including from the private sector), as well as supporting commercialisation efforts and helping companies attract talent, which Europe is gradually getting better at.

Where Europe is notoriously bad is funding and scaling up its excellent university spin-offs. These startups often cannot turn innovative technology into a solid product-market fit. Fixed costs and the enormous bureaucracy that founders face must be reduced. That’s where investors should step in and provide more operational and organisational support to researchers-turned-founders.

The solution is for VCs and governments to work toward the same goal: The former should challenge themselves to invest more in dual-use technologies, and the latter should give those startups a chance to help Europe regain its technological sovereignty.

Uwe Horstmann is a co-founder and partner of the Berlin-based venture capital firm Project A Ventures.

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