The UK’s deep tech sector is navigating a seismic shift in investor sentiment toward defence technology.
Once a frowned-upon sector, defence is now shedding its taboo, driven primarily by global instability and recent geopolitical headwinds.
This transformation, while opening the doors to new investment opportunities, also reveals underlying issues in the UK’s approach to technology and national security.
Speaking to City AM, Ben Prade, partner at Bullhound Capital, said: “Two years ago, defence technology was like pornography or gambling”, “now it’s almost taking up the ‘S’ of ESG.”
He explained that the war in Ukraine has served as a “big kick up the backside” for Europe, raising concerns around the urgent need for robust defence capabilities and subsequently forcing a reevaluation of what was once considered ‘wokeism’ around war and conflict.
This sentiment reflects recent market trends, where British defence stocks, such as Babcock, BAE Systems, and Rolls-Royce, have seen significant gains amid a surge in defence spending.
Serco, too, saw its order pipeline rise to a decade high of £11.9bn, with 80 per cent of new orders related to defence.
Dual-use technologies
For many UK and European investors, the shift has primarily benefited dual-use technologies, innovations that serve both military and civilian purposes, such as cyber intelligence, secure communications, or AI.
As Prade explained, “You can’t invest in weaponry, so anything that kills people you can’t invest in. But right now, you’ve gone over a supply of money going into non-weaponry related stuff when unrelated things have to be funded”.
For venture capital (VCs) like Bullhound, this allows capital to flow into firms with both commercial viability and significant government sales potential, making them more attractive investments.
However, the UK faces a unique challenge as its defence sector is heavily reliant on the US, a dependency that could be easily exploited.
Prade highlighted this strategic vulnerability, noting that a reliance on foreign-controlled software and systems leaves the nation susceptible to being “switched off at any point”.
This makes cultivating domestic tech leadership key for maintaining the UK’s strategic autonomy.
The UK’s negotiating power is weak, and its ability to build a fighting force to rival powers like Russia independently is limited. Instead, to combat this, the UK must focus on its strengths.
UK’s quantum edge
Prade identified the UK’s “front card” as quantum technology: “I think we are leaders in quantum, our universities, our academics”, he added.
The potential of this field extends beyond computing to applications such as quantum sensing, which can serve as a GPS alternative by mapping gravitational fields.
Prade cites an example of a firm that developed a quantum sensor from a non-military background, which is now being rolled out on Airbus planes, a technology that no government had previously considered investing in directly.
This highlights the type of technology that can be developed independently to give the UK a competitive edge, underscoring the need for a more proactive and forward-thinking investment strategy.
A call for a new funding model
Despite a commitment to increase defence spending, with Prime Minister Keir Starmer aiming for 2.5 per cent of GDP by 2027, the effectiveness of this spending is under scrutiny.
The traditional government procurement model, where tenders are issued for specific, often outdated, equipment such as tanks, is a significant issue.
“That is why our forces are behind everyone else”, Prade stated. This outdated model often results in the acquisition of technology that is already obsolete.
A more effective approach, Prade argues, involves a symbiotic partnership between the government and private capital.
The Spanish government, for instance, used a VC firm to perform due diligence and then invested a much larger sum in a promising AI company.
This model would see the government act as a “first customer”, de-risking early-stage investments for VC funds by providing guaranteed orders.
This would incentivise private funding for high-risk, high-reward ventures.
Whilst this hasn’t been done effectively in the UK, it is a practice that could “really stimulate the deep tech space”, according to Prade.
Europe’s threat
The UK’s ability to capitalise on these opportunities is being hampered by systemic issues.
Brexit has created a barrier to entry for talented young Europeans, and the tax system can be a disincentive for founders considering a major liquidity event.
“Savvy founders will obviously realise that they will be taxed really, really badly” after which “they start thinking of relocating to the US,” Prade explained.
Meanwhile, Germany is rapidly becoming a major tech hub. “In Q2 was the first time there was more funding that went into startups in Germany than in the UK”, Prade revealed.
With the German government releasing significant funds and fostering a strong manufacturing base, the country is poised to overtake the UK.
The UK, on the other hand, is struggling to retain talent and create a competitive environment.
This “stifling” business climate, coupled with a government that seems to lack the “will or inclination” to make it more helpful, poses a serious threat to the UK’s position as a global tech leader.
To secure its future negotiating position on the world stage, the UK must shift its focus from old-school procurement to investing in the deep technologies it excels at, particularly quantum.
The path forward requires a fundamental change in mindset, moving away from a reactive, cash-first approach to a proactive, innovation-led strategy.