Increase in European defense sector creates new opportunities for mergers and investments.

The defense landscape in Europe is evolving significantly due to the pressing need for European sovereign capability following the events in Ukraine. Governments are rapidly increasing procurement to address this need and are emphasizing the importance of innovation in a technology-driven battlefield. This shift towards innovation has created a favorable environment for investment and M&A activity, particularly for small and medium-sized enterprises (SMEs) that are pioneering emerging defense technologies.

European defense spending has seen a remarkable surge, with expenditures totaling $693 billion in 2024, marking a 17% increase from previous years. This increase surpasses Cold War levels and highlights the significant commitment to strengthening defense across the continent. Countries like Germany and Poland have shown substantial growth in defense spending, with initiatives like Germany’s special defense fund and Poland’s long-term dedication to defense investments contributing to this trend.

New commitments are also driving this surge, such as the European Commission’s “ReArm Europe Plan/Readiness 2030” and the U.K.’s pledge to raise defense spending as a percentage of GDP in the coming years. Regulatory measures, including considering defense readiness in M&A reviews and clarifying ESG rules on defense investment, are being proposed to attract private capital flows alongside increased government spending.

With a focus on innovation in areas like cyber, AI, quantum, and software-defined warfare, SMEs are well-positioned to succeed in the evolving defense sector. Traditional defense procurement focused on large prime contractors, but the shift towards specialized software expertise and rapid development cycles in new technologies presents opportunities for SMEs. Governments across Europe are increasing their direct investment in innovation by SMEs, with initiatives like the U.K.’s Strategic Defence Review and the NATO Innovation Fund supporting startups developing disruptive technologies.

Private equity investors are also actively participating in this growing market and are seeking quality assets within the defense sector. The U.K.’s Ministry of Defence and other European innovation hubs are creating platforms to accelerate the development of cutting-edge defense technologies from SMEs. This increased investment flow alongside direct defense procurement opportunities is crucial for SMEs looking to grow in the defense sector and attract better valuations from strategic acquirers.

Beyond traditional defense players, commercial solutions and dual-use technologies are gaining prominence in delivering military advantage. Governments are looking towards adaptable commercial solutions with shorter timeframes for operational readiness. Innovators in emerging technology sectors like AI, cyber, quantum computing, and advanced materials can benefit from the defense market by understanding where their solutions have potential defense applications.

In conclusion, the European defense market is witnessing a revitalization with heightened government expenditure and a strategic emphasis on innovation. This presents a compelling environment for M&A and investment activity, particularly for SMEs at the forefront of emerging defense technologies and dual-use solutions.