By Supantha Mukherjee, Sarah Marsh and Christoph Steitz
MUNICH/BERLIN/FRANKFURT (Reuters) -For Gundbert Scherf – the co-founder of Germany’s Helsing, Europe’s most valuable defence start-up – Russia’s invasion of Ukraine changed everything.
Scherf had to fight hard to attract investment after starting his company – which produces military strike drones and battlefield AI – four years ago.
Now, that’s the least of his problems. The Munich-based company more than doubled its valuation to $12 billion at a fundraising last month.
“Europe this year, for the first time in decades, is spending more on defense technology acquisition than the U.S.,” said Scherf.
The former partner at McKinsey & Company says Europe may be on the cusp of a transformation in defence innovation akin to the Manhattan Project – the scientific push that saw the U.S. rapidly develop nuclear weapons during World War Two.
“Europe is now coming to terms with defense.”
Reuters spoke to two dozens executives, investors and policymakers to examine how Germany – Europe’s largest economy – aims to play a central role in the rearming the continent.
Chancellor Friedrich Merz’s government views AI and start-up technology as key to its defence plans and is slashing bureaucracy to connect startups directly to the upper echelons of its military, the sources told Reuters.
Shaped by the trauma of Nazi militarism and a strong postwar pacifist ethos, Germany long maintained a relatively small and cautious defence sector, sheltered by U.S. security guarantees.
Germany’s business model, shaped by a deep aversion to risk, has also favoured incremental improvements over disruptive innovation.
No more. With U.S. military support now more uncertain, Germany – one of the biggest backers of Ukraine – plans to nearly triple its regular defence budget to around 162 billion euros ($175 billion) per year by 2029.
Much of that money will go into reinventing the nature of warfare, the sources said.
Helsing is part of a wave of German defence start-ups developing cutting-edge technology, from tank-like AI robots and unmanned mini-submarines to battle-ready spy cockroaches.
“We want to help give Europe its spine back,” said Scherf.
Some of these smaller firms are now advising the government alongside established firms – so-called primes such as Rheinmetall and Hensoldt – that have less incentive to focus primarily on innovation, given their long backlogs for conventional systems, one of the sources said.
A new draft procurement law, expected to be approved by Merz’s cabinet on Wednesday, aims to reduce hurdles for cash-strapped start-ups to join tenders by enabling advance payment to these firms, according to a version dated June 25, reviewed by Reuters.
The law would also entitle authorities to limit tenders to bidders inside the European Union.
Marc Wietfeld, CEO and founder of autonomous robots maker ARX Robotics, said a recent meeting with German defence minister Boris Pistorius hammered home how deep the rethink in Berlin goes.
“He told me: ‘Money is no longer an excuse – it’s there now’. That was a turning point,” he said.
GERMANY IN THE LEAD
Since Donald Trump’s return to the political stage and his renewed questioning of America’s commitment to NATO, Germany has committed to meet the alliance’s new target of 3.5% of GDP on defense spending by 2029 – faster than most European allies.
Officials in Berlin have emphasized the need to foster a European defence industry rather than rely on U.S. companies. But the hurdles towards scaling up industry champions in Germany – and Europe more broadly – are considerable.
Unlike in the United States, the market is fragmented in Europe. Each country has its own set of procurement standards to fulfill contracts.
The United States, the world’s top military spender, already has an established stable of defence giants, like Lockheed Martin and RTX, and an advantage in key areas, including satellite technology, fighter jets and precise-guided munitions.
Washington also began boosting defence tech startups in 2015 – including Shield AI, drone maker Anduril and software company Palantir – by awarding them parts of military contracts.
European startups until recently languished with little government support.
But an analysis by Aviation Week in May showed Europe’s 19 top defence spenders – including Turkey and Ukraine – were projected to spend 180.1 billion this year on military procurement compared, to 175.6 billion for the United States. Washington’s overall military spending will remain higher.
Hans Christoph Atzpodien, head of Germany’s security and defence sector association BDSV, said one challenge was that the military’s procurement system was geared toward established suppliers and not well suited to the fast pace that new technologies require.
Germany’s defence ministry said in a statement it was taking steps to accelerate procurement and to better integrate startups in order to make new technologies quickly available to the Bundeswehr.
Annette Lehnigk-Emden, head of the armed forces’ powerful procurement agency, highlighted drones and AI as emerging fields that Germany needs to develop.
“The changes they’re bringing to the battlefield are as revolutionary as the introduction of the machine gun, tank, or airplane,” she told Reuters.
SPY COCKROACHES
Sven Weizenegger, who heads up the Cyber Innovation hub, the Bundeswehr’s innovation accelerator, said the war in Ukraine was also changing social attitudes, removing a stigma towards working in the defence sector.
“Germany has developed a whole new openness towards the issue of security since the invasion,” he said.
Weizenegger said he was receiving 20-30 Linkedin requests a day, compared to maybe 2-3 weekly back in 2020, with ideas for defence technology to develop.
Some of the ideas under development feel akin to science fiction – like Swarm Biotactics’ cyborg cockroaches that are equipped with specialised miniature backpacks that enable real-time data collection via cameras for example.
Electrical stimuli should allow humans to control the insects’ movements remotely. The aim is for them to provide surveillance information in hostile environments – for example information about enemy positions.
“Our bio-robots – based on living insects – are equipped with neural stimulation, sensors, and secure communication modules,” said CEO Stefan Wilhelm. “They can be steered individually or operate autonomously in swarms.
In the first half of the 20th century, German scientists pioneered many military technologies that became global standards, from ballistic missiles to jet aircraft and guided weapons. But following its defeat in World War II, Germany was demilitarized and its scientific talent was dispersed.
Wernher von Braun, who invented the first ballistic missile for the Nazis, was one of hundreds of German scientists and engineers transported to the United States in the wake of World War II, where he later worked at NASA and developed the rocket that took Apollo spacecraft to the Moon.
In recent decades, defence innovation has been a powerful driver of economic progress. Tech like the internet, GPS, semiconductors and jet engines originated in military research programs before transforming civilian life.
Hit by high energy prices, a slowdown in demand for its exports and competition from China, Germany’s $4.75 trillion economy contracted over the last two years. Expanding military research could provide an economic fillip.
“We just need to get to this mindset: a strong defense industrial base means a strong economy and innovation on steroids,” said Markus Federle, managing partner at defence-focused investment firm Tholus Capital.
ESCAPING ‘THE VALLEY OF DEATH’
Risk aversion among European investors had in the past disadvantaged startups, which struggled to get the capital they need to survive the ‘valley of death’ – the critical early stage when costs are high and sales low.
But a boost in defence spending by European governments following Russia’s invasion of Ukraine has investors looking for opportunities.
Europe now boasts three start-ups with a unicorn valuation of more than $1 billion: Helsing, German drone maker Quantum Systems, and Portugal’s Tekever, which also manufactures drones.
“There’s a lot of pressure now on Germany being the lead nation of the European defense,” said Sven Kruck, Quantum’s chief strategy officer.
Germany has become Ukraine’s second-biggest military backer after the United States. Orders that might once have taken years to approve now take months and European startups have had the opportunity to test their products quickly in the field, several sources said.
Venture capital funding of European defence tech hit $1 billion in 2024, up from a modest $373 million in 2022, and is expected to surge even more this year.
“Society has recognized that we have to defend our democracies,” said Christian Saller, general partner at HV Capital, an investor in both ARX and Quantum Systems.
Venture capital funding has grown faster in Germany than elsewhere, according to a data analysis by Dealroom for Reuters. German defence startups have received $1.4 billion in the last five years from investors, followed by UK, the data shows.
Jack Wang, partner at venture capital firm Project A, said many German defence startups – rooted in the country’s engineering prowess – are good at integrating established components into scalable systems.
“Quality of talent in Europe is extremely high, but as a whole, there’s no better country, no better talent that we’ve seen other than in Germany,” he said.
Weakness in Germany’s automotive industry means there is production capacity to spare, including in the Mittelstand: the small and medium-sized enterprises (SMEs) that form the backbone of Germany’s economy.
Stefan Thumann, CEO of Bavarian startup Donaustahl, which produces loitering munitions, said he receives 3 to 5 applications daily from workers at automotive companies.
“The startups just need the brains to do the engineering and prototyping,” he said. “And the German Mittelstand will be their muscles.”
($1 = 0.8560 euros)
(Reporting by Supantha Mukherjee in Munich, Sarah Marsh in Berlin and Christoph Steitz in Frankfurt; Additional Reporting by Sabine Siebold in Berlin; Editing by Kenneth Li and Daniel Flynn)
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