Last week, I met with the founder of a precision machining company. Twenty-two years in business. $35M revenue. 40% EBITDA margins. Several major primes and several very large startups depend on their components.
They were raising a Series A.
“Why?” I asked.
“We’re tech enabled and producing deeptech components. And we’re growing. VCs love that. And that’s what you do when you’re growing. Right?”
Wrong.
The Irony That Kills Me
European pension funds and endowments allocate less than 0.1% of their assets to venture capital. They treat it like plutonium—dangerous, volatile, handle with extreme care.
[Sidenote: Ironically, they might also be right to do so. Too many managers in Europe cannot produce returns that are adequate for the risk class and look more like a 8-12% net IRR, competing with an S&P500 index fund, but illiquid and with locked-in capital for 12-14 years. But that’s another story…]
Yet when these same institutions look at defense technology, suddenly everything needs a venture structure.
A family-owned precision manufacturer in Huntsville? Must be VC-backable. A specialized contractor with NATO clearances? Surely needs a growth round. A company making irreplaceable components for missile systems? Time for a cap table.
The very investors who understand that venture capital is a specialized, high-risk asset class somehow forget this wisdom the moment someone mentions “defense tech.”
The $6 Billion Magnitude of Misallocation
In 2024, venture capital deployed approximately $8.2 billion into defense tech. Based on my analysis of 200+ defense deals, I estimate that 60-70% of these companies—representing $5-6 billion—would have been better served by alternative capital structures.
[What I’d love to know more about: What percentage of these companies actually achieved venture-scale returns? How many are still operating five years later? I suspect the data would be damning, but also a bit unfair: most venture-backed startups fail, and even 200 companies are rather anecdotal to find statistically relevant and material differences from, say, IT Infrastructure or Enterprise Software.]
What’s the real cost?
Direct Costs:
- Founders giving up 20-40% equity for growth they don’t need
- Companies hiring 100 engineers when 20 would suffice
- Opening Bay Area offices when cleared talent is in Huntsville
- Abandoning profitable hardware for speculative software plays
Hidden Costs:
- 40% of VC-backed defense companies fail not from technology risk but from growth-induced operational collapse
- When a specialized manufacturer fails, that knowledge disappears forever
- Consolidation pressure eliminates the diverse supplier base DoD desperately needs
Strategic Costs:
- Single points of failure in critical supply chains
- Loss of irreplaceable manufacturing knowledge
- Weakened negotiating position with prime contractors
- Reduced innovation from smaller, specialized suppliers
A Tale of Two Companies
Company A: Builds specialized RF components for radar systems. $42M revenue. Growing 15% annually. Founder is 58, looking to retire in 7 years. Employs 45 people, most with security clearances.
Company B: AI-powered drone swarm technology. Pre-revenue. Stanford founders. Could revolutionize battlefield surveillance. Needs $50M to build and test.
Both pitched me last month. Guess which one was seeking venture capital?
Both of them.
Company B makes sense—high risk, high reward, exponential potential. Classic VC. But Company A? They need succession planning and working capital, not a growth mandate that will destroy what makes them valuable.
The VC Distortion Field
When venture capital enters businesses like Company A, it warps them beyond recognition. Teams are incentivized to chase addressable markets instead of defending sovereign capacity. This misalignment isn’t a bug; it’s a feature of a capital system that was built to fund global category leaders, not warfighting resilience.
Before VC:
- 45 employees who know every system
- Founder-led sales to program managers
- 3-year product cycles matching procurement
- Focus on reliability over features
- Profitable unit economics
After VC:
- 200 employees including a “growth team”
- Enterprise sales motion to wrong buyers
- 6-month product sprints misaligned with acquisition
- Feature bloat reducing reliability
- headcount expansion, vanity metrics, and slideware narratives for VC board members
- Burn rate exceeding revenue
I’ve watched this movie dozens of times. It always ends the same way.
Voices from the Field – What I’m Hearing From Others
A defense tech founder who wishes to remain anonymous told me: “We took VC money because that’s what everyone said we should do. Three years later, we’re unrecognizable. We used to build things that worked. Now we build things that demo well.”
To paraphrase conversations with several smaller fund managers: They see the problem but feel trapped by LP expectations. One told me, “I know this company doesn’t need our capital structure, but if I don’t invest, someone else will—and at least I can try to minimize the damage.”
[What I wish I knew: How many European family offices or smaller institutions have actually considered defense-focused alternative structures? What stopped them? Was it regulatory concerns, lack of precedent, or simply inertia?]
What They Actually Need
Private equity won’t touch most of these companies either. They’re too small. Too technical. Too hard to underwrite with a spreadsheet. The result? A capital void for mission-critical businesses in the $25M–$100M valuation range—particularly in Tier 2 and Tier 3 suppliers, cyber-hard infrastructure, and advanced manufacturing for national defense.
We don’t just need better startups. We need better capital formation models. Defense innovation can’t rely on a single modality of venture funding. Not when the mission demands durability, not just growth.
As Howard Marks observed:
“When you find an investment with the potential to compound over a long period of time, one of the hardest things is to be patient and maintain your position as long as doing so is warranted on the basis of the prospective return and risk… When you look at the chart for something that’s gone up and to the right for 20 years, think about all the times a holder would have had to convince himself not to sell.” — Howard Marks, “Selling Out” Oaktree Capital Management memo (January 2022)
The tragedy is that better options exist—they’re just not as visible or valorized:
Revenue-Based Financing
- Aligned with government contract cycles
- No dilution
- Patient capital matching natural growth
Strategic Investment from Primes
- Technical collaboration
- Guaranteed revenue streams
- Natural succession planning
Micro Private Equity
- Succession solutions for aging founders
- Professionalization without transformation
- Distributions over exits
- 5-25 year horizons (two different products: short hold AND long hold!)
The European Paradox
Here’s what makes me want to bang my head against the wall: These same European institutions that avoid venture capital like the plague would be PERFECT for alternative defense financing vehicles:
“National Resilience Innovation Bridge”
- Target: Strategic manufacturers facing succession
- Returns: 12-18% IRR through steady distributions
- Structure: closer to Private Equity operating partnership than debt financing
- Purpose: Sustain production capacity through succession transformation
- Timeline: 5-8 years matching procurement cycles and succession cycles
- Risk: Lower than VC, backed by government contracts
“Defense Industrial Base Preservation Fund”
- Target: Critical suppliers needing working capital
- Returns: 8-15% IRR through steady distributions
- Strategic Returns: Acquirer of smaller startup teams
- Structure: Revenue-based with small equity upside, closer to debt financing than Private Equity operating partnership
- Purpose: Maintain competitive supplier ecosystem
- Timeline: 10-25 years
- Risk: Lower than PE, backed by government contracts and manufacturing insights and network
- Alignment: National security meets long-term capital stewardship
European LPs understand infrastructure. They understand industrial assets. They understand patient capital. They just don’t understand why everything in defense is being forced through a venture capital meat grinder. Imagine a world where Company A could access patient capital aligned with their natural growth rate. They’d maintain their culture of excellence. Their founder could plan a graceful succession. Their employees could focus on engineering rather than fundraising roadshows.
Now multiply that by the hundreds of similar companies across the defense industrial base. We’d have:
- Faster innovation cycles aligned with real needs
- More resilient supply chains
- Preserved institutional knowledge
- Lower costs for DoD programs
[The question I can’t answer: Would this alternative ecosystem generate comparable financial returns? My hypothesis is yes—lower volatility, steadier distributions, strategic premiums on exit. But we need someone to prove it.]
I’ve Passed on These Deals
And it hurts.
These are good companies with great founders building critical capabilities. But I can’t invest because my LPs expect venture returns, and forcing these companies to chase 10x growth would destroy them.
I know what happens next. They’ll find someone who will take their money. That someone will push them to hire aggressively, expand geographically, and pivot to software. In three years, they’ll be dead or unrecognizable. The VCs will shrug their shoulders, “one of these risky tech businesses that didn’t work out” while the owners, employees, and their families lost their livelihood.
Meanwhile, we’ll have lost another irreplaceable node in our defense supply chain.
The Path Forward
We need a fundamental reimagining of capital formation in defense:
1. Education
Stop telling every defense entrepreneur they need to raise VC. The best money is often no money—bootstrapping on contracts.
2. New Vehicles
Create fund structures that match defense realities:
- 10-15 year funds aligned with procurement cycles
- Revenue-based returns for steady growers
- Permanent capital for strategic assets
- Succession funds for aging founders
3. LP Evolution
Help European institutions see the opportunity:
- Lower risk than VC
- Strategic value beyond financial returns
- Alignment with their infrastructure mindset
- True portfolio diversification
4. Narrative Change
We also need to change the narrative. We should celebrate companies that can build $40M in resilient revenue with strong cash flow and no need for cap table drama. These are the backbone of defense sovereignty—call it “hard tech middle market,” “mission-critical Mittelstand,” or simply the industrial base that keeps deterrence credible. Celebrate the $40M precision manufacturer as much as the $4B unicorn. Both serve critical roles. Only one needs venture capital.
An Invitation to Think Differently
- If you’re a defense entrepreneur: What capital structure actually serves your mission?
- If you’re a European LP: What if you could access defense tech returns without venture risk?
- If you’re a fellow VC: How many great companies have we destroyed by forcing them into our model?
Not every missile needs a cap table. Not every innovation needs an exit. Not every defense company should scale exponentially.
Sometimes the highest ROI comes from letting a great $40M business remain a great $40M business—profitable, strategic, and enduring.
That’s not a failure of ambition. It’s a success of judgment.
And maybe, just maybe, it’s time for those careful European institutions to fund the vehicles that would actually preserve these vital capabilities. They already know venture capital isn’t for everyone.
They just need to realize the same is true in defense.
What am I missing? What data would strengthen this argument? What anecdotes speak against this argument? If you have insights on alternative capital structures in defense, security, resilience, and European sovereignty, or if you have counter-examples of thriving companies, then I’d love to hear from you at tc@thinkstorm.com