A challenging fundraising landscape is highlighting the sectors and companies in which investors hold strong conviction, along with those that fail to attract attention outside of bullish markets. While AI startups have led the pack in dealmaking this year, another sector attracting significant venture capital interest is defense technology.
A recent illustration of this trend occurred on Tuesday, when Shield AI secured a substantial $200 million Series F funding round, spearheaded by Thomas Tull’s US Innovative Technology Fund, with contributions from Snowpoint Ventures and Riot Ventures. This investment values the San Diego-based autonomous drone and aircraft manufacturer at an impressive $2.7 billion.
The magnitude of this funding round stands out in today's market, where "mega-rounds" exceeding $100 million have become increasingly rare. According to PitchBook, only 194 rounds over the $100 million mark were executed through the third quarter of 2023, a significant drop from 538 in 2022 and 841 in 2021. Additionally, late-stage funding has remained subdued for much of this year. Late-stage startups received just over $57.3 billion in investments through the third quarter, a stark decline compared to the $94 billion raised in 2022 and the $152 billion in 2021.
Brandon Tseng, co-founder and president of Shield AI, explained that the company successfully raised funds in this environment primarily due to its impressive performance metrics. Shield AI is experiencing an astounding 90% year-over-year revenue growth and is projected to reach profitability by 2025.
This funding round is particularly noteworthy not just for its size, but also for the sector it represents, signaling a strong shift in investor focus towards defense technology in recent years. Tseng noted that investor interest in defense startups has significantly improved, contrasting sharply with the challenges Shield AI faced during its early fundraising efforts.
Eight years ago, Silicon Valley was hesitant to invest in defense technology. However, a series of factors have shifted investor sentiments dramatically.
Importantly, the sector now boasts success stories that investors can look to as benchmarks for growth and performance. For example, Palantir Technologies secured $3 billion in venture funding before going public at a $16.5 billion valuation, and currently boasts a market cap of $40 billion, making it one of the few successful venture IPOs from 2021. Anduril Industries, valued at $8.5 billion, appears poised for a lucrative exit as well. With such compelling comparables, investors can now confidently assess the potential returns of startups within this sector.
“Defense tech is incredibly challenging,” Tseng commented. “You need to be specifically designed to navigate this landscape. Collaborating with government agencies presents numerous challenges. Defense technology is fundamentally distinct from other markets. I find it exciting to see this field evolve and for Shield AI to be part of that journey.”
Shield AI is not alone in its fundraising achievements; other defense startups have also completed significant funding rounds this year. For instance, Lyten, a manufacturer of lithium battery materials, raised $200 million in September, while defense AI startup Helsing secured a $223 million Series B round that same month.
Defense technology has demonstrated resilience even in economic downturns, as its primary clients—government entities—maintain consistent budgets that are less influenced by market fluctuations compared to private companies. Moreover, the critical problems that defense tech addresses will persist even during tougher economic times.
“Investors view defense as a counter-cyclical sector,” Tseng remarked. “During market downturns, government spending remains stable, which helps VCs mitigate risks.”
Given this perspective, it’s not surprising to see a continual rise in investments within defense technology, especially as the number of companies in this field expands. Early-stage defense startups, like ARX with its $1.2 million pre-seed round and Shift5 with a $33 million Series B, are already capitalizing on this trend.
As global tensions reveal vulnerabilities within the defense sector, it’s likely that more entrepreneurs will emerge with innovative solutions. Growing investor interest in this category is a crucial driver of this trend.
“The world is increasingly perceived as unsafe. I'd argue that we are less stable today than in 2013,” Tseng stated. “Investors recognize that global stability is essential for macroeconomic growth. Strong deterrents play a key role in ensuring that stability, and companies like Shield AI are integral to achieving that.”
If the funding landscape continues to contract in 2024—an outcome that seems probable—defense technology will likely remain one of the few sectors experiencing growth in investment and new company formation.
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