Private capital is flooding into defense technology companies at unprecedented levels. Venture funds are "pouring money into defense startups," Bloomberg reports, with defense-related U.S. startups raising more funding since early 2023 than in the previous nine years combined. AI defense technology alone has attracted billions in investment this year.
Private equity shows similar acceleration, with aerospace and defense investments in early 2025 already approaching the entire previous year's total. McKinsey reports global venture capital investments in defense companies jumped 33 percent year over year.
This dramatic acceleration signals more than just increased capital flows; it represents a fundamental strategic recognition that defense companies, specifically defense technology companies, are essential to national security and long-term geopolitical stability.
These companies enable the foundational conditions for all other societal goals. Democracy, political freedom, social stability, economic prosperity, and human rights depend on strong national defense capabilities. Defense technology is the foundation of all sustainability, and achieving resilient national defense requires substantial private capital investment.
This creates a fundamental dilemma for investors who systematically exclude defense companies from their portfolios: they can recognize national security as a social good and invest in companies that help achieve this good or continue to ban defense-related investment and, as one defense sector source told Responsible Investor, act like “mob wives,” content to enjoy the security brought by the defense sector without knowing “how the sausage is made.”
I aim to resolve this dilemma. But first, some background.
Why focus on defense companies now?
Russia's invasion of Ukraine demonstrates that effective national defense, both as a deterrent and a combat capability, requires technological superiority. Contemporary military advantage increasingly stems from the integration of commercially developed AI systems, autonomous platforms, cybersecurity capabilities, space assets, and advanced materials. Yet, according to Stanford Professor Steve Blank, "For the first time ever, the DoD [Department of Defense] no longer owns all the technology necessary to win a war."
This deficit comes as the U.S. faces escalating threats from transnational actors and major adversaries — China, Russia, Iran, and North Korea. China poses the most significant strategic challenge through its coordinated efforts to militarize advanced technologies, including quantum computing, AI, and advanced manufacturing, as well as other critical domains, thereby threatening to undermine U.S. military and economic advantages.
A Rand Commission study concludes that "China is outpacing the United States and has largely negated the U.S. military advantage in the Western Pacific through two decades of focused military investment. Without significant change by the United States, the balance of power will continue to shift in China's favor."
This significant change requires the U.S. military to acquire and deliver emerging technologies to its warfighters rapidly. (While this article primarily focuses on the U.S., the same argument could be made for the United Kingdom and the European Union.)
The U.S. government and the DoD recognize the need to modernize the country’s defense capabilities. The proposed 2026 defense budget is $1 trillion, once again exceeding the combined military spending of the next nine largest defense budgets worldwide.
However, the size of this budget doesn't guarantee military modernization. The vast majority of DoD contracts have traditionally been awarded to established defense contractors, such as Lockheed Martin and Northrop Grumman; however, these companies haven't consistently bridged the innovation gap. The top five defense primes allocate only 3 percent of their total revenue to research and development — a small fraction of the government's research, development,test, and evaluation (RDT&E) budget and significantly below that of commercial tech leaders. In contrast, major technology companies invest 11 percent of their much larger revenue base in R&D, enabling faster innovation and technological breakthroughs.
The Pentagon is increasingly finding the transformative technological solutions it needs from nontraditional contractors, typically private, early-stage growth companies. (The DoD defines a nontraditional defense contractor as an entity that hasn't performed defense work for at least one year before a contract solicitation.)
Unlike established defense contractors, these nontraditional companies lack easy access to the private capital needed to quickly design, develop, and deploy their technological solutions at scale. Without this funding, they risk withering in the valley of death.
Recognizing the urgent need for fast innovation and deployment, the DoD is establishing new contracting frameworks to support emerging technology companies and startups. These frameworks aim to help these companies deliver advanced capabilities at commercial speed and scale to address the military's most pressing operational requirements.
For example, in March, Defense Secretary Pete Hegseth designated the commercial solutions opening (CSO) as the default contracting approach for software acquisition programs.
The Defense Innovation Unit (DIU), established in 2015 and now with a $1 billion budget, developed CSO in 2016 to rapidly connect the DoD with commercial technology companies. The DIU identifies operational challenges across military services and manages the entire solution development process — from vendor solicitation through prototype awards using other transaction authority.
CSO dramatically accelerates procurement timelines from years to months, reducing barriers for commercial innovators through business-friendly processes rather than complex federal acquisition regulations. The flexible agreements allow negotiable terms and creative deal structures that accommodate commercial business models.
Results demonstrate effectiveness: more than 270 prototype agreements have been awarded, with more than 40 percent successfully transitioning from prototype to fielded military technologies. The DIU provides program management at no cost to DoD partners, though partners must fund prototype development and participate in assessments.
In 2024, NATO launched a similar program, the Defense Innovation Accelerator for the North Atlantic (DIANA). DIANA’s mission is to leverage emerging and disruptive technologies to strengthen NATO's competitive advantage in collective defense and security. DIANA now operates 23 accelerator sites and 182 test centers across 28 countries, having more than doubled its network since launch.
While the DIU and similar DoD programs function as a contracting agency without investment capabilities, the DoD established the Office of Strategic Capital (OSC) in 2022 to attract private capital to national security priorities and increase private investment in critical technologies.
The OSC acts as a government-backed investment catalyst, using financial tools to fill private capital gaps for critical national security technologies.
The OSC bridges the valley of death between technology development and full-scale production through direct loans ($10 million to $150 million per project) and loan guarantees for companies developing microelectronics, advanced computing, biotechnology, and clean energy capabilities.
The OSC partners with the Small Business Administration and leverages programs such as the Small Business Investment Company Critical Technologies (SBICCT) initiative to align private capital with national security priorities. By identifying investment gaps and providing financial backing, the OSC attracts private investments that help companies scale from prototype to operational deployment.
The SBICCT’s first cohort of 13 private equity and venture capital funds is projected to invest more than $4 billion in nearly 1,700 portfolio companies, focusing on all 14 of the DoD’s critical technology areas, as well as strategic component technologies and production processes. These funds plan investments across seed, venture, growth, buyout, direct-lending, special-situations, and fund-of-funds strategies.
Buoyed by the DoD’s commitment to supporting private capital and the remarkable success of such defense startups as Anduril Industries and Palantir Technologies, private equity and venture capital firms are significantly increasing their funding commitments to private defense companies in 2025. For example, found that AI defense technology startups alone have secured $1.5 billion in funding this year, with projections indicating $6 billion by year-end. Private equity follows this same accelerating trend. In just the first 12 weeks of 2025, private-equity-backed investments in aerospace and defense had already reached $4.27 billion globally — nearly equaling the $4.31 billion invested throughout all of 2024.This increased funding reflects strong confidence in emerging technologies positioned to revolutionize autonomous systems, advanced manufacturing, robotics, and other mission-critical capabilities.
Despite the size of the DoD’s budget and its streamlined procurement frameworks and current private capital flows, additional private investment is needed to achieve the DoD’s goal of rapid modernization.
And this takes us back to our dilemma.
Many allocators have traditionally excluded defense companies from their ESG portfolios due to concerns about their involvement in weapons manufacturing and their association with military conflict and potential human rights abuses: “I have no problem with people investing in weapons companies or stock, but don’t do it under the sort of umbrella of ESG or sustainability, because it’s not. These are products that kill people,” said one chief investment strategy officer.
I would describe this as an old-world view of ESG, one founded on the false equivalence between defense companies and weapons — false because many defense companies don't simply manufacture weapons. While this old-world view may apply to established players like General Dynamics, most early-stage defense companies develop dual-use, non-weapons-critical technologies. These technologies serve both military and civilian markets. Dual-use companies aren't new. DuPont, Boeing, Lockheed, and Raytheon are early examples of such companies founded with private capital. Contemporary examples include defense tech unicorns such as Anduril, Palantir, and SpaceX and startups like Tomorrow.io and Cyvl.
Because dual-use companies focus on a specific product or technology and have a defined go-to-market plan, allocators can determine if companies are directly producing weapons.
And these dual-use companies are attracting private capital. As Pitchbook reports, “VCs are increasingly prioritizing startups with dual-use revenue streams.” Critically, more than 70 percent of private deals now involve firms with dual-revenue streams.
To meet the military's need for rapid development and large-scale deployment of these dual-use technologies, more private capital is essential. However, the old-world view of ESG prohibits many allocators from investing in these defense tech companies.
To capitalize on and support the Pentagon’s push for modernization, allocators should adopt a more nuanced and pragmatic ESG framework that recognizes national defense as a social good and supports investment in dual-use defense companies with strong governance, labor, and environmental practices, while excluding those involved in banned or controversial weapons like anti-personnel mines, cluster munitions, and chemical or biological weapons. The framework could also require that eligible companies operate within the U.S. and conduct business only with American, NATO, and allied governments. Such a framework would do more than enhance national security; it would also strengthen supply chains, drive economic growth by building up domestic industrial capacity, and create jobs at home.
Investors concerned about the environmental impact of emerging dual-use defense technology companies can either avoid companies with unacceptable practices or invest in those that prioritize sustainability, including companies developing clean energy solutions for military applications, advanced materials with lower environmental impact, and efficient manufacturing processes. Many of these emerging companies actively promote their environmental credentials, as they recognize that sustainable practices not only attract ESG-conscious capital but also align with the military's own sustainability goals, such as reducing fossil-fuel dependency and improving operational efficiency through cleaner technologies (for example, from Air Co. and Sage Geosystems.
Allocators are also aware that dual-use companies present compelling investment opportunities as these companies can tap into larger and more diverse markets, innovate more quickly, operate more efficiently, generate revenue from multiple sources sooner, and typically offer more substantial exit potential than defense-only businesses.
Some leading ESG asset managers are adopting such a framework. In an email to Bloomberg, LGIM said, “There is no reason in principle why investing in certain defense companies can’t be consistent with responsible investing, as long as they’re not producing controversial weapons or providing conventional arms to high-risk countries. As a fiduciary, we will continue to cater to different client needs and preferences across our range of funds and solutions,” adding, “we believe that countries have an inherent right to self-defense.”
To increase the flows of private capital investment into defense companies, governments are encouraging the integration of defense companies into ESG investment offerings. The European Union, which has a comprehensive ESG framework that is widely regarded as the most advanced and ambitious globally, is considering allowing defense companies to be included in certain ESG-labelled investment products, provided they meet evolving transparency and ethical standards.
Likewise, the U.K. government has clarified that defense companies can be included in ESG investments under its current regulatory framework, with some British officials going so far as to claim that ESG investors are “trying to immorally defund British defence. There are not too many ESG outfits in Russia or North Korea.”
While the U.S. lacks a unified ESG investment framework, under the Trump administration, the U.S. Department of Labor will likely permit investment in defense companies and oppose restrictions on fiduciary investment decisions based solely on ESG considerations.
The nuanced ESG framework outlined above has another consequence: It undermines political criticism that openly labels ESG investing "woke" activism. An ESG approach that allows private investment in defense technology companies cannot easily be characterized as woke.
The U.S. and its allies are under constant and evolving threats from both state and transnational actors. Deterring and combating these threats requires a robust national defense, which, in turn, necessitates a robust defense industry.
The industry requires capital to develop solutions that give warfighters an operational advantage. Since Russia's invasion of Ukraine, it has become evident that this advantage will come from the rapid achievement of technological superiority in several critical areas. These technologies will be developed by traditional defense companies and, increasingly, by private, early-stage dual-use defense companies.
While governments are creating frameworks to expedite the acquisition of these technologies, and PE and VC are investing in private dual-use companies, these companies — and many not yet established — need more private capital to deliver new capabilities on commercial timelines.
A dogmatic approach to ESG investing should not prevent these investments. To deploy capital at the necessary scale, ESG investors must reassess their policy on investing in defense companies. This reassessment must start by acknowledging that national defense is the mother of all sustainability. As Micael Johansson, CEO of Swedish defense company Saab, makes clear, “if you don’t have any security and a deterrent effect, then you can’t talk about the ESG from other perspectives. That’s sort of the foundation of sustainability in my eye.”
This premise enables ESG investors to navigate the shoals of sustainable investing and contribute to national defense by allowing them to invest in emerging, private dual-use defense technology companies that meet their investment criteria. Investing in defense companies inevitably involves complexity and challenges, but, given the urgent need to modernize and strengthen our military capabilities and the potential returns these emerging defense-tech companies offer, ESG investors should consider adding “D” to their understanding of ESG.
Angelo Calvello, PhD, founder of C/79 Consulting LLC and writes extensively on the impact of AI on institutional investing. All views expressed herein are solely the authors and not those of any entity with which the author is affiliated.
