“90% of drone startups will fail in five years”: Europe's defence tech beyond drones

0:28Essentially, there are just way too many drone startups. kind of predicted to me that we're going to see basically 90 % of these startups fail in the next five years. Hello, and welcome to the Sifted podcast. I'm Amy, Sifted's editor and your host. And today I'm joined by my colleague, Berlin-based senior reporter Anne Schraders, who has in the last year or so become rather an expert on Europe's very fast growing defense tech industry, which is what we're going to be talking about on this show. Anne, hello. Hi, Amy. Thanks for having me back on the pod. you're very welcome so I very excitingly for me spent the first part of this week at the resilience conference which is a gathering of startups spies and soldiers which is not exactly the kind of event I would have expected to attend when I started at sifted when just about no investors would touch defense well I'm really curious I unfortunately wasn't able to be there Amy but I would love to hear your takeaways what the vibe was give me give me the rundown.

1:27So I'm probably still not allowed to disclose the location I had to arrive with my passport I was given a badge which had Amy L written on it and everyone's everyone was like that everyone was Andy P or Caroline D or whatever and then what was also really funny was there was one conference room where all the panels were happening there were some very hench bouncer type people who were very vigilant if anyone took photos they would come over and tell you off and make them make you delete them from your phone and then you'd also sometimes have speakers who would you know be on stage they weren't wearing balaclavas or anything but their their picture behind them on the screen was just like a kind of blacked out silhouette and their job description would be something like senior service personnel UK government so it's just a very bizarre very different from other startup events that I have attended I mean the silhouette pictures are a bit strange to me given that we could see who these people were on stage and sure we weren't allowed to take photos of them but yeah I guess I don't fully understand the inner workings of the security services and why some of these people needed to have that level of mystery around them.

2:44That sounds familiar. I went to a similar kind of small conference event, I believe it was last year, and similarly was not expecting it to be, you know, there's no picture up there. It's just sort of this like Facebook icon image. And it's, yeah, it is quite a different vibe to the normal types of conferences I think we're used to. So that's really interesting. Yeah, and there were lots and lots of UK government people there, which was quite interesting. And I guess one of my takeaways was that it felt like, well, A, I learned that there are all these government departments that I have literally never heard of.

3:17There were people from GCHQ, which I think lots of people know of the kind of traditionally what we see as, you know, the SPI, the intelligence agency, MI6, NSIF, the National Security Strategic Investment Fund, which is a fund set up by the security services to invest in startups, which we've been covering a bit as if did. But then there were all these other organizations like HMGCC, His Majesty's Government Communication Centre, and a new one, CSOC, the Cyber and Specialist Operations Command. So just heaps of these departments are all various ways working on security. And what was interesting is that they were all very keen to work with startups, I guess, evidenced by the fact that they were at this conference and they were all trying to be more open in some ways about how they were working.

4:06so that startups could kind of understand how they might work with them in the future which I imagine is not the way things would have been five or so years ago there were lots of startups there a lot of them were doing drones and then there were the kind of big players you'd expect there was Helsing which we've spoken about on the podcast before there was also a founder called Lorenz Meyer who's just raised 130 million dollars for his startup Orterion which is also doing drones, drone swarms. And it's very interesting. They all have slightly different perspectives on how this industry is going to fall out.

4:43Because Anne, you've been writing a lot about this. You wrote a very popular piece last week about how there are perhaps slightly too many drone startups at the moment. Yeah. So, I mean, I think this is something that I've been thinking about for a long time. And a lot of my sources have been kind of mentioning here and there. Essentially, there are just way too many drone startups. I mean, SIFT did alone tracks over 100. And we sort of did the numbers crunching and found out that drone startups in Europe have raised over 70 % of all defense and dual use funding so far this year. So, you know, clearly taking a huge portion of the pie, of course, a lot of that went to Helsing's 600 million euro round earlier this year.

5:23But I think, you know, clearly, this is a huge topic. I think it makes a lot of sense, as we talked about before, this is such a massive area of technological innovation. I think drone warfare has become such a huge component of the war in Ukraine. And I think they're seeing so many technological advances essentially on a weekly basis. So it makes a lot of sense that founders want to come and build in this space. But I think what we're seeing now is that there are so many companies targeting the exact same customers. They're building very similar products. I think a lot of people say They look really similar.

5:55Maybe there's differentiation based on speed or the load they can carry or things like that. But essentially, one VC described it as kind of fragmentation. And so I think what we're going to see, as with any market that becomes super hot really quickly, is we're going to see the winners emerge and we're going to see the losers emerge. And I think one investor kind of predicted to me that we're going to see basically 90 % of these startups fail in the next five years. And so I think what that's going to look like is maybe, you know, certainly we'll see some companies potentially go under, but I think we'll also see a lot of consolidation, a lot of M &A.

6:30So, you know, maybe it's going to be a Helsing, maybe it's going to be a Stark or Quantum Systems or someone who just buys up a lot of these other smaller companies. Maybe it's for, you know, some hardware component or the team or something like that. But I think that's definitely on the horizon because, yeah, as you said, there are so many drones. That's a huge topic. And I think we're looking at, you know, a lot of founders are kind of looking for ways to differentiate themselves. And I actually interviewed Lorenz recently about Altirion. And he said, you know, he thinks that within drone software, it's going to be, you know, one winner, a winner takes all.

7:04I don't really think that's going to be the case with the hardware drones. I think we will kind of see these sort of, as we call it, local champions, national champions emerge. But yeah, it kind of remains to be seen at this point. Yeah. And that's a big debate as well over whether there's a need for these national champions. A stat that someone quoted on stage, I'm probably going to get it slightly wrong, but it was like in the early era of the car industry, there were like hundreds of car companies in America. And they were saying this is a kind of similar thing. You don't need hundreds of car manufacturers and every country doesn't even need its own car manufacturer.

7:43Obviously, it's different when we're talking about something that's strategically important for defence. But I had a conversation with Fiona Murray, who's the new chair of the NATO Innovation Fund, about this. And her prediction was that, yes, there will be some, you know, Germany will likely have its own sort of big new sort of neo-prime company. The UK likely will, but it's not like every single country in Europe will. And another thing that's kind of up for debate is, say, some of these German companies like Helsing Quantum Systems, they're all working in countries like the UK. But sometimes the stipulation of that is that they need to make sure that they are able to manufacture their products in the UK.

8:30So it might be more a case that it needs to be done sort of onshore. And that makes it kind of safe enough for the government to work with these players. But then there's the whole other conversation of the supply chain, which came up quite a bit at this conference of, okay, so you're making drones, say, in the UK or in Germany. But where do the components for those drones come from? and again Lorenz from in or Tyrion said to me that some of these smaller drone companies is highly likely that a lot of their components are coming from places like China because they're still kind of at that hobbyist or like playing around prototyping stage he thought that by the time you get to a much more established company sure some of the parts might be coming from other bits of the world but they might be coming from Japan or Taiwan or Korea or wherever else someone else pointed out to me but if you go really really macro things like critical minerals that are important for all of these products loads of them are kind of processed or produced in china no one else in the world does them so again this was something that fiona murray said she thought would be increasingly interesting and looked at in the future is if we go really deep and far down the supply chain, you know, who's working on ensuring the West has their own ways of accessing and producing those things that you wouldn't know are in products, but are incredibly important for them.

10:04Yeah, I think that's, I mean, that's a huge topic as well, right? Because I think it sort of falls under this umbrella that we talk about sometimes mockingly of quote unquote resilience, but I think it actually is talking about a resilient supply chain from the very beginning, as you said, critical minerals, there are some companies working on that sort of very early side, even going so early as to use a geothermal energy for mining of critical minerals in Europe. And then there's companies working on kind of lightweight carbon fiber structures used in defense and aerospace. So we're seeing, you know, companies kind of all across the supply chain working on these issues.

10:40And there's also companies like Eisenbard in the UK that's trying to work on the manufacturing side. There's a lot of these sort of small family owned machine shops all over the UK and Europe that essentially maybe the family is about to retire. And so, you know, what's going to happen to it? And it's about kind of creating this essentially re-industrializing Europe. I think, you know, there's a lot of talk about how it's sort of become very dependent on, as you mentioned, China, other places. And I think that's certainly a huge push that maybe isn't so obvious when you think about defenses like, you know, critical minerals or manufacturing, but it's such a huge component, as you said, of kind of the end product there and making sure that, you know, those concerns about sovereignty really are addressed in that sense.

11:18Because I think, you know, as you mentioned, Amy, like so many of these startups do end up using, you know, little bits and pieces from China because they're either cheaper or the best, or there's not really a good alternative. And so I think that's a huge issue that a lot of people talk about as like needing to be addressed. A quick one from me, the Sifted Summit is back. This October, join a whole load of Europe's smartest founders, investors and operators, along with its very best tech journalists, for two days of expertly moderated and thought-provoking conversations and extremely valuable networking.

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12:34Whether you're newish to the startup world and want to get some practical advice and insights, or an old hat wanting to make some new great connections, the Sifted Summit is where you need to be. So grab your ticket now at summit.sifted.eu, and because you're a Sifted podcast listener, use code POD20 for 20 % off. I think something else we'll probably start to see over the next year or so is people kind of tying together that European industrial base a bit more and figuring out how if we were to enter into a more war situation than we're currently in, how Europe as a whole would be able to manufacture the things it would need.

13:15So I spoke to one Ukrainian investor who'd done at D3, they had done a piece of work to look at where in Europe could things be manufactured if necessary based on all sorts of things to do with cost to do with the workforce to do with the existence of the factories and things and she said that Romania came up top because Romania apparently used to have a quite kind of cheap car industry the cost of labor is still low So I was also speaking to an investor in a company called Orca, which has manufacturing facilities in Croatia. Again, cost of labor is very low there. They're good at doing these things.

13:53And that's a company that actually supplies components to a lot of other drone makers. So as you mentioned, also Ismbar, I expect we'll see more of these companies crop up. And I also think we'll see sort of traditional industrial players like the car manufacturers, for example, potentially seeing this as a kind of future-proofing exercise for themselves it's you know a new line of work that they could get into this it's definitely a whole lot of you know drones are just the tip of the iceberg there's so much more to the defense industry that people are you know figuring out I think at the moment that's certainly true and I think I mean I guess speaking of of more than drones I think another area that is really top of mind right now for a lot of people is this air defense interceptor drone type of companies because you know clearly in the last few days.

14:40In the last few weeks, we've seen unidentified drone sightings over Denmark, it shut down airports. And this is something that is becoming really concerning beyond just Ukraine, I think, for a lot of governments. So startups working on this particular area is certainly a huge topic of conversation among investors and founders at the moment. Yeah, maybe the most powerful panel was two Ukrainian soldiers came on stage in their full their full army gear and they were talking about how at the moment they're only able to intercept 10 % of the Russian drones that come into their airspace and so that they do need more of these sort of things that can intercept them they were also really stressing two things one was that these products have to be cheap you know we're in a different era now it's not like having the most amazing submarine that takes a decade to make and costs gazillions of pounds is I mean obviously I think governments still need those but they also need this these just like huge amount of very cheap things because they are you know just going to get used up or shot down or whatever and then the other thing that they were stressing is that they need to be able to iterate these products extremely quickly and what was very interesting is they were talking about how they have engineers and developers embedded in battalions.

16:03I'm not sure if they're actually sort of like right on the front line, but they're very close. And there were a few different startups that came on stage, one called Tiberius Aerospace, which is based in the US, but one of the founders is British. And they were talking about sort of creating products that people on the front line can kind of hack in real time so kind of tweak the the software like as they go because you know something multiple people on stage are stressing it's just you know the enemy is adapting day by day and you just have to kind of match up and you can't expect the same software and equipment to be relevant three months down the line and so any company that isn't able to adapt like that isn't really relevant for them in this kind of warfare.

16:52Yeah, I think that's a big component of what we're seeing generally across the board with drone technology right now is, as you said, it essentially becomes kind of outdated within sometimes like weeks, sometimes months. And so I think that's a big challenge. I think the other big challenge in particular for the air defense type of companies that I've been speaking with some investors and founders about is that for many of these companies, they're kind of building the drone maybe, or they're doing something with radars. And so it's sort of one piece of the puzzle. But specifically for air defense, there's multiple components going on.

17:25There's the detection, there's the radar, there's actually shooting it down. So there's a lot of these things that if a company is building one piece of that, they have to kind of plug into the rest of the system. And that can be maybe a bit more complicated. And so I think that's why I've been speaking with some investors who are very interested in this space, but they're maybe a bit still on the fence, or they're still not sure exactly what the play is here because it can be kind of this complicated industry where there just requires a lot of integrating into existing systems as well. Yeah. And I think there's a lot still to be developed and figured out when it comes to the kind of capital requirements of a lot of these businesses.

18:02I think VCs have very much flocked to drones and there were quite a lot of sarcastic comments about classic VC herd mentality, all investing in the same thing when, as we've been discussing, there are all these other areas of defense that they've not all rushed into. But when we're talking about, you know, potentially like huge scale manufacturing, lots of these companies aren't necessarily VC backable, or they're not maybe like some of the kind of climate tech companies we'd be talking about a few years ago, they're going to require funding from, from banks or from big strategic players or, you know, they're going to require all different types of financing that aren't just, you know, equity funding.

18:47And I'm not, I'm not sure we've really seen that figured out yet, because it's still quite a nascent industry, isn't it? Yeah, I think I mean, that's something that I ask investors a lot is, you know, is this actually a VC case? Like, what, you know, why do you need to be the one to invest in this? And I think some of them are still thinking that through. And I think I was speaking with investor even just earlier this morning, who was essentially like, yeah, I think, you know, the certain part of the drone space is not something that really makes sense for VCs. And I think that's something that also is, you know, we're going to figure that out kind of as time goes on.

19:17And, you know, things are going to kind of emerge. I will say with even with the counter UAS systems type of startups, we are seeing a number of them recently that have become a bit more like well invested, I think, in particular, the UK's Cambridge Aerospace, they announced they raised over 130 million recently, they've kind of been in stealth before. And there's a couple other ones. There's one in Latvia called Origin Robotics. Germany has Alpine Eagle and Titan. So, you know, there are a number of startups that are starting to gain, you know, kind of VC money, interest, all these things. So I think will be interesting to see who kind of emerges from that space as well, who VCs deem as, you know, maybe a VC case.

19:56But yeah, certainly a lot of figuring out, I think, for investors in this landscape. Yeah. And there's a lot, this was, there was a presentation from the NATO Innovation fund which kind of opened up the the conference and they were talking about how a big push for them over the next few years will be to try and bring the different parts of the ecosystem together so that we would have the traditional primes the big the Lockheed Martins and Ryan Mattel who have traditionally made these bits of equipment with the startups but also with as I mentioned earlier, the kind of the car manufacturers or the, you know, hundreds of thousands of small manufacturers in Germany that are capable of doing these things.

20:38And that, yeah, those relationships need to be built and that there is perhaps a role for kind of government to help make those happen. Did they talk about how government would help make this happen? Not specifically. I'm looking at the presentation now. They were talking about how we were already seeing lots of partnerships between the big companies. So Leonardo and Physics X, which is a startup, German shipbuilding company, NVL, which is working with British startup Kraken. We've seen startups partnering with startups. So ARX Robotics and Helsing, for example. So I guess they're anticipating that we just see a lot more of those over the years to come.

21:19Yeah, I think, I mean, that's certainly been kind of historically a component of the defense space is it's very much like a partnership-based type of industry. And so I think that's sort of where the prime comes from, right? It's like the company that has the direct initial relationship with the government. And I think they kind of bring in other folks into the fold. I think Alterion also, I believe, has a partnership with Ryan Mattel. So yeah, I think that is one kind of interesting element of the defense space is that there will be a lot of working together. And I think the question will sort of be, when is it working together versus when are they like, hey, maybe I'll just buy this smaller company and bring it in the fold.

21:56So I think that'll be kind of interesting to see how that folds out too. And we maybe haven't talked as much as we should have done about the huge role government is playing here, you know, with all the NATO countries hugely increasing their investment into defence. Poland, 5 % of GDP investment in defense spending by 2026. Germany's aiming to get it to 3.5 % by 2029, which is up from 1.75. So a huge, a huge increase. But how much of that do we think is going to be heading to startups, do you reckon? I think that is the big question that founders and investors are asking themselves right now, because clearly, you know, seeing these commitments, seeing these numbers, seeing theoretically how much will be invested in this space has been a major sort of push for why we're seeing such a huge hype in defense tech at the moment.

22:49But I think, as you said, I think the big question is, okay, that's great. The headline numbers are huge, but how much will actually go to startups? Because I think the important thing to remember about this industry is that it is very slow moving. It's very based on long-term stable relationships. It's very risk averse for, you know, for good reasons, because this technology is really important, and it has to perform when it needs to perform. But I think, you know, there is a question of, you know, can startups kind of whittle their way into those relationships? Can they actually impress the government with our technology?

23:20You know, will they be able to spend a lot of time working on, you know, trying to get these contracts, and that procurement process can take a long time, like years, essentially. And so I think that's sort of what people are asking themselves. I I spoke with someone who was working on the Strategic Defense Review, which was published earlier this year in the UK. And sort of the line that I get a lot is, you know, it remains to be seen if this is actually going to happen, if the money will flow into the bank accounts of these startups. So I think that's, you know, that's the big question. Everyone is sort of, you know, vying for these contracts.

23:53Everyone, you know, does think that, you know, there will be more movement towards startups. But I think that it's sort of cautious optimism at this point. Yeah, the NSIF, this Security Services Fund for Startups, the head, he did say on stage that it is now possible for them to get from seeing an idea to contract within 10 days, which seemed remarkably fast for a government organisation. So they've, they clearly have got the message that they need to move fast. I guess it is just a case of whether in enough instances, they do move fast enough for, you know, startups to want to work with them and for it to make sense, as we were talking about earlier, for the needs of the people on the on the front line.

24:39Yeah, I mean, I've written about the number of European defense startups who have government contracts across Europe and the US. And so, you know, clearly it is happening. But I think, I mean, certainly, probably the number one complaint I get when I talk to founders is the government, the procurement process is terrible, it needs to change. So, you know, famously, government is not the most fast moving, innovative type of organization. But I think, you know, we are starting to see bits and pieces of that actually happening. But again, I think, you know, I would wager that a lot of that money probably won't end up going to startups.

25:13So I think, you know, we'll have to see what happens. But I think it's, you know, definitely that the primes are still there for a reason. They've been around forever and the government likes them. So where do you think we'll see more money heading outside of drones over the next while? I heard one person on stage talk about the five domains of defense, which I'd never heard it described in this way. And those are air. So plenty going into that. Maritime. We've been talking a bit about sort of undersea drones, land, but also cyber as a domain, which I quite like, and space. And we are definitely seeing a lot more interest in sort of space tech and satellites and that side of things as well, that side of surveillance.

25:56I mean, I think, you know, I'm not sure exactly in terms of like quantities of money flowing into these spaces, but I think space for one is a huge priority because essentially Europe is pretty much fully reliant on SpaceX at this point. You know, they really need their own launcher. But I think cyber is another area that I've been hearing more about and I think is really critical because you see, I mean, even in Europe, I think it was a week or two ago, there was these sort of cyber attacks that essentially shut down airports. And so this is something that we're seeing kind of escalating. And I think that's certainly maybe an overlooked part of the industry because it's not, you know, drones and guns and weapons.

26:34But I think it's a huge component of what we need to address for the future. Yeah, I did also have people say, we're already at war, we're just in a cyber war. And people, you know, don't really understand the quantity of attacks that are being fended off every day, which is a little scary. Back to the world of startups. And apart from Helsing, maybe, Quantum Systems, which other European defence tech startups are you really interested in watching closely at the moment? Yeah, almost from just a curiosity standpoint as well. I'm really interested in what we talked about a bit earlier in terms of the critical minerals, the manufacturing startups.

27:15So I think that that's something that I just want to learn more about as well. And I think it's kind of interesting from that, as we said, supply chain standpoint, because I think that's a huge issue that's maybe not as sexy or as talked about as the drone. So I think that's a really interesting space. And then, you know, certainly based on what I'm researching at the moment for some stories, I think the air defense system companies is just going to be really interesting. I was speaking to an investor who said that a lot of those companies are still kind of in the R &D phase. So I think we're sort of yet to be seen, you know, how many of these companies are actually producing, you know, products that will, you know, fly off the shelves, be used a lot in real life.

27:50But I think it's a super interesting and important area to be watching. So that's kind of where I'm looking at the moment. So if you are listening and you have something to add on anything we've talked about today, but especially the critical minerals, the supply chain, re-industrializing Europe angle, please get in touch. I'm amy at sifted.eu. Anne is anne at sifted.eu. And Anne, thank you so much. This has been a really super interesting conversation. Thanks, Amy. if you want to hear more from ann every week you can sign up to her newsletter upround which comes out every friday we will drop a link in the episode description but also drop some links to some of the articles we've mentioned and if you would like to win a pair of headphones worth 250 pounds please take our listener survey which you can also find in the episode description i promise it will take you less than five minutes it will probably take you two minutes and it will really really help us grow the podcast and that is all we have time for today thank you to tim smith who produced the episode