Defence tech investment hit $38 billion through the first half of 2025 while overall VC funding declined. That’s market resilience worth paying attention to.
This analysis is part of our comprehensive guide on deep tech and defense innovation, examining the opportunities, risks, and strategic lessons shaping the sector in 2025.
Government co-investment programs have changed the game. The Office of Strategic Capital, SBIR/STTR, and STRATFI/TACFI are creating hybrid funding models that bridge public and private capital. Investment is flowing into autonomous systems, AI/ML, cybersecurity, and hypersonics.
For you, this landscape reveals strategic partnership opportunities and dual-use technology potential. Understanding how these funding mechanisms work helps you make better build vs buy decisions.
The major players? Established VC firms like Founders Fund and Sands Capital, startups like Anduril at $14 billion valuation, and new government funding mechanisms that are changing the game.
What is driving the surge in defense tech venture capital investment in 2025?
Global security tensions. Ukraine. Indo-Pacific competition. Governments are funding solutions and treating defence modernisation as a top priority.
DoD‘s FY2026 budget proposes $832 billion in discretionary funding, including $148 billion for research, development, test and evaluation. That’s real money flowing to emerging technologies and non-traditional contractors.
Dual-use technology is the key. It lets defence tech companies serve both government and commercial markets. Defence contracts provide the stability, commercial sales drive the volume and scale.
Government co-investment programs take the edge off investor risk. The Office of Strategic Capital, STRATFI, and TACFI match private capital with public funding. Anduril’s $1.5 billion Series F demonstrates there’s a viable path to scale and profitability.
Traditional prime contractors are partnering with or acquiring startups. That creates exit opportunities for investors. And commercial technology adaptation? It’s proving faster and more cost-effective than the traditional defence R&D cycles.
Defence tech funding reached $3 billion in 102 deals in 2024, an 11% uptick from 2023. The investor base grew from fewer than 100 firms in 2017 to more than 300 different firms in 2024. We’re talking Andreessen Horowitz, Alumni Ventures, 8VC, Founders Fund, and General Catalyst.
How do government co-investment programs like the Office of Strategic Capital actually work?
OSC provides loans and loan guarantees. Not equity investments. This helps defence tech companies attract private capital without diluting ownership.
Here’s the typical structure – your company raises a private funding round, then OSC provides a matching loan to reduce dilution and extend your runway. Direct loans are available up to $150 million to finance projects in the United States.
To be eligible you need to be developing technologies aligned with the National Defense Science and Technology Strategy. You’ll need to demonstrate private investor interest and show a pathway to DoD procurement.
Loan terms include below-market interest rates and flexible repayment tied to contract milestones. Convertible structures are available too. The advantage? Accessing growth capital without surrendering equity or control to government entities.
OSC has deployed over $1 billion since 2022 across autonomous systems, AI, and advanced manufacturing.
STRATFI and TACFI work a bit differently. They provide DoD matching funds to private investment. STRATFI handles the larger awards – $5M to $50M – for strategic technologies and multi-year programs. TACFI provides smaller awards, $1M to $10M, for tactical solutions with faster deployment timelines.
Both require a 1:1 private capital match, DoD end-user validation, and a pathway to Program of Record. Applications go through service innovation hubs. AFWERX handles Air Force STRATFI. NavalX handles Navy programs.
What is the SBIR funding pathway and how do startups transition from Phase I to production contracts?
SBIR Phase I gets you $50,000 to $275,000 over 6 to 12 months for proof of concept. Phase II supports prototype development with $400,000 to $1.8 million over 24 months. Phase III is where you commercialise the technology, but there’s no SBIR/STTR funding provided during this phase.
Here’s the hard truth. Only 16% of DoD SBIR-funded companies received Phase III contracts over the last decade. Fewer than 1% of Phase I awardees achieve Program of Record status.
SBIR awards are often called a “licence to hunt” because Phase I and II contracts don’t guarantee a long-term deal or path to large scale programs. But what they do is grant startups access to DoD stakeholders. You get to demonstrate customer demand and open doors to broader adoption.
Service innovation hubs like AFWERX and NavalX streamline the SBIR application process and accelerate evaluation timelines. They’re your entry point into the system.
What critical technology areas are receiving the most defense investment in 2025?
Advanced computing and software leads cumulative investment at $90 billion from 2015 to first half 2025. Sensing, connectivity and security received $43 billion. Autonomous systems hit $26 billion. Space technology got $24 billion.
Most VC in defence has clustered around dual-use technologies – autonomy, AI-enabled decision systems, simulation, and sensing.
Dual-use technologies combine tangible deep-tech innovation with scalable software-led characteristics that investors find attractive. Shield AI, Skydio, and Applied Intuition were awarded OT prototyping contracts through DIU. The Hypersonix Launch Systems $46 million Series A round demonstrates how breakthrough propulsion technology can attract both government and private capital.
How do dual-use technologies change the economics of defense tech startups?
Dual-use enables revenue diversification. Defence contracts provide the stability. Commercial sales drive the volume and scale. Commercial markets typically offer faster procurement cycles – months instead of years – and lower regulatory overhead.
Defence validation creates commercial credibility. “If it’s good enough for the military” messaging resonates with enterprise buyers.
The challenges? ITAR restrictions limit international sales and technology transfer to commercial products. Successful dual-use requires separate product lines, distinct go-to-market strategies, and careful IP management.
Some examples: Cybersecurity firms turn defence-grade tech into enterprise zero-trust platforms. AI/ML companies convert intelligence analysis capabilities into predictive analytics products. Autonomous systems makers turn military drones into commercial inspection platforms.
The economics shift from government-dependent to commercially scalable, with defence as a strategic anchor customer.
U.S. scaleups like Shield AI, SpaceX, and Palantir demonstrated the efficacy of vertically integrated platforms initially focused on defence but now bridging the civil-military divide.
What is the Valley of Death in defense tech and how are companies bridging it?
The Valley of Death is an 18 to 36 month funding gap. It sits between a successful SBIR Phase II prototype and a Phase III production contract. DoD’s PPBE budget cycle requires 2 to 3 years of planning to insert a new Program of Record. That creates this cash flow gap.
95-98% of SBIR Phase II recipients fail to achieve Program of Record status. Often it’s because of the Valley of Death.
STRATFI matches private investment dollar-for-dollar to fund transition activities. OSC loans provide below-market financing to extend runway. Prime contractor partnerships offer bridge funding in exchange for teaming agreements or acquisition options.
Breaking through requires understanding how DoD funds procurement at scale. Most successful startups combine multiple approaches – securing SBIR funding for credibility, using OTA contracts for rapid prototyping, partnering with a PEO to scale into a Program of Record.
How should you evaluate build vs buy decisions for defense technology capabilities?
DoD increasingly favours “buy and integrate” from startups over traditional in-house development.
Build advantages: custom fit to requirements, IP ownership, no vendor lock-in, higher security control. Buy advantages: faster deployment (12 to 18 months vs 3 to 5 years), lower upfront cost, proven technology.
The key evaluation factors are technology maturity, competitive advantage vs commodity, time-to-deployment urgency, and total cost of ownership. For a comprehensive framework on navigating these innovation opportunities and strategic trade-offs in the defense tech sector, see our complete guide.
A hybrid approach is emerging. Buy a commercial dual-use core, then customise the integration layer for classified applications. This gets you speed and cost efficiency while maintaining security requirements.
CMMC compliance, FedRAMP requirements, and ITAR restrictions apply whether you build or buy. OTAs facilitate access to new and commercial technologies outside standard government acquisition pathways.
What role do prime contractors play in the defense tech startup ecosystem?
Partnering with prime contractors – Lockheed Martin, RTX, Northrop Grumman, General Dynamics, Boeing – provides an entry point. Primes have established relationships, programs of record, contract vehicles, and deep institutional knowledge of military procurement.
Teaming with primes can offer much faster sales cycles for startups with products that align to existing programs.
The trade-off: subcontracting often means less control, lower margins, and longer sales cycles that limit your ability to drive change. But primes are massive customers constantly seeking innovative suppliers to integrate modern technology into defence programs.
The top 10 defense contractors retained about 65% market share across key segments over the past 10 years. That’s despite significant investment in new entrants.
Position yourself as an indispensable enabler. Leverage the primes’ scale while retaining a strategic path to long-term growth.
FAQ Section
What compliance certifications does my company need before selling to the Department of Defense?
You’ll need FedRAMP authorisation for cloud-based services handling DoD data. CMMC Level 2 certification – that’s 110 controls – is required for contractors handling Controlled Unclassified Information. ITAR registration is necessary if you’re developing or exporting defence articles. And facility clearance is needed for classified work.
Timeline? 12 to 18 months total for the full compliance stack. Start with CMMC as the foundational requirement.
Can international investors participate in US defense tech funding rounds?
Foreign investment is permitted for unclassified dual-use technologies not subject to ITAR controls. But CFIUS review is required for foreign ownership exceeding 10% voting interest or 25% total equity.
UK, Australia, Canada – the Five Eyes partners – face fewer restrictions. Alternative approach: Foreign investors can participate through US-domiciled funds or as limited partners without board representation.
How long does it typically take to go from SBIR Phase I to a production contract?
SBIR Phase I takes 6 to 12 months. Phase II takes 24 months. Then there’s the Valley of Death gap at 18 to 36 months. Program of Record insertion adds another 12 to 24 months. Total timeline: 5 to 8 years from initial SBIR award to sustained production revenue.
Only 2 to 5% of companies complete this journey. Acceleration is possible through OTA rapid prototyping – that’s a 2 to 3 year pathway – or prime contractor teaming.
What is an Other Transaction Agreement and when should startups use it?
OTA is a flexible contracting mechanism that’s exempt from Federal Acquisition Regulation (FAR) requirements. It enables rapid prototyping and production without the traditional procurement processes.
There are two types. Prototyping OTAs for technology demonstration. Production OTAs for follow-on manufacturing. Best used for dual-use commercial technologies, rapid iteration cycles, and non-traditional defence contractors.
You can access OTAs through the Defense Innovation Unit, service innovation hubs like AFWERX and NavalX, and OTA consortia like the National Security Innovation Network.
How do European defense tech funding models differ from US programs?
Europe has the National Security Strategic Investment Fund in the UK, the European Defence Fund that’s EU-wide, and individual country programs in France and Germany. Key differences: less restrictive export controls – there’s no ITAR equivalent – smaller individual fund sizes at $200M to $500M vs the multi-billion dollar US programs, and a stronger emphasis on NATO interoperability.
Advantages for US startups: dual-market strategy, less competition, faster procurement cycles. Challenges: currency risk, separate regulatory compliance, and relationship building required.
What percentage of defense tech startups successfully achieve Program of Record status?
2 to 5% of SBIR Phase II recipients achieve Program of Record insertion. Of companies that enter the Valley of Death, approximately 15 to 20% successfully bridge to production contracts.
Success factors: a strong operational champion within the military service, demonstrated cost savings vs the incumbent solution, alignment with PPBE budget priorities, and bridge funding through STRATFI, OSC, or prime partnerships. Timeline averages 5 to 8 years from initial SBIR to sustained production revenue.
Do I need security clearances to work on defense tech projects?
Depends on the classification level of the work. Unclassified work: no personal clearances required. Controlled Unclassified Information (CUI): no clearance needed but CMMC compliance is required. Secret or Top Secret work: facility clearance and employee clearances are mandatory.
Clearance timeline: 6 to 18 months depending on the level. Cost: $3,000 to $5,000 per employee for Secret, $10,000 plus for Top Secret. Many dual-use opportunities exist without classification requirements.
What are STRATFI and TACFI programs and how do they differ?
STRATFI – Strategic Financing – and TACFI – Tactical Financing – provide DoD matching funds to private investment. STRATFI handles larger awards, $5M to $50M, for strategic technologies and multi-year programs. TACFI provides smaller awards, $1M to $10M, for tactical solutions with faster deployment.
Both require a 1:1 private capital match, DoD end-user validation, and a pathway to Program of Record. Application is through service innovation hubs. AFWERX for Air Force STRATFI. NavalX for Navy programs.
How does the PPBE cycle affect when my technology can be adopted?
PPBE – Planning, Programming, Budget, Execution – is DoD’s 2 to 3 year budget planning process. Planning year: define requirements and priorities. Programming year: allocate resources to programs. Budget year: Congressional appropriation. Execution: spend the appropriated funds.
Impact on you: a new Program of Record requires 2 to 3 years of PPBE insertion. This creates the Valley of Death. Your strategy should be to target mid-year requirements reviews, demonstrate cost savings to justify budget reallocation, and secure an operational champion to advocate in the planning cycle.
Can my commercial tech company transition to defense without prior military experience?
Yes, via the Defense Innovation Unit, service innovation hubs, and SBIR programs that are specifically designed for non-traditional contractors. Success factors: identify the dual-use application of your existing technology, partner with a military end-user for validation, and leverage your commercial traction as credibility.
Entry paths: DIU Commercial Solutions Opening (CSO) for rapid prototyping, SBIR for funded development, and OTA consortia for teaming opportunities. Avoid attempting traditional FAR-based procurement without experienced partners.
What are the typical terms for Office of Strategic Capital loans?
Loan structure: senior secured debt or subordinated convertible notes. Interest rates: below commercial rates, typically 3 to 6% vs 8 to 12% market rates. Repayment terms: milestone-based tied to contract awards, 3 to 7 year maturity.
Collateral: IP, contracts, equipment. Less stringent than commercial lenders. Conversion features: some loans are convertible to equity at future rounds. Amounts: $10M to $200M depending on company stage and private capital raised. The advantage? Non-dilutive capital extending your runway through the Valley of Death.
How do I identify the right Program Executive Office for my technology?
Map your technology to the DoD service and capability area. Army has 11 PEOs covering ground vehicles, aviation, missiles, soldier systems, and enterprise IT. Navy has 8 PEOs including ships, submarines, aircraft, and information warfare. Air Force has 7 PEOs for fighters, bombers, space, nuclear, and command and control.
Research the Future Years Defense Program (FYDP) for budget allocations. Attend industry days. Engage through the Defense Innovation Unit or service innovation hubs. Build relationships with PEO technical staff before any formal procurement starts.
Strategic Considerations for Defense Tech Investment
Understanding the funding landscape is crucial, but it’s just one aspect of navigating the deep tech strategy shaping defense innovation in 2025. The intersection of government co-investment, venture capital, and breakthrough technologies creates unique opportunities for companies willing to engage with defense procurement complexity.
The 2025 defense tech investment environment offers unprecedented access to capital through hybrid funding models. Success requires understanding multiple funding pathways, navigating regulatory requirements, and positioning technology for both defense and commercial markets. Whether you’re evaluating strategic partnerships or build vs buy decisions, the key is aligning your technology roadmap with DoD procurement cycles while maintaining commercial viability.
