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Defence-related small and medium-sized enterprises (SMEs) are key enablers of innovation and growth. Europe’s defence industry should be fully able to draw upon the innovations coming from SMEs; including those SMEs that are mainly active in civil industries. More than 2,500 SMEs are playing a central role in the complex defence supply chains in Europe. However, an over-riding characteristic of these supply chains is that they function largely on a national basis, with limited cross-border cooperation.

Despite being an important part of the defence supply chain, SMEs face considerable challenges in cross-border access to defence and security contracts. These range from legal, administrative, and language obstacles to barriers presented by limited/no access to classified information, security of supply requirements, standardisation, certification, and national export control regulations.

While the EU urges defence companies to ramp up production to meet rising security needs, small and medium-sized enterprises (SMEs) still face significant roadblocks when it comes to securing financing. There is a disconnect between high-level political ambition and the everyday reality for companies operating in Europe’s defence sector, especially its smaller players. Many SMEs remain locked out of crucial financial services due to the application of environmental, social and governance (ESG) rules. Because defence is not explicitly classified as sustainable under the EU’s taxonomy, ESG standards can lead to defence companies being excluded from financing or essential services. The result? Some banks and service providers refuse to offer loans, accounts, or even energy contracts to defence firms – or their suppliers. The challenge is particularly acute for defence startups. Raising capital in the sector is extremely difficult because “you need to raise more capital than another project for a single potential client in the longer term and that potential client is limited to maybe one, the state. Grant schemes such as the European Defence Fund (EDF) involve a significant administrative burden which can be difficult for startups to manage.  Without faster access to capital, SMEs may struggle to deliver on Europe’s strategic ambitions.

Private equity, combined with public initiatives like the European Defence Industrial Strategy (EDIS), holds the potential to transform Europe’s fragmented defence market by mobilising resources, driving innovation, and improving competitiveness, ultimately strengthening the EU’s military capabilities and strategic autonomy.

AALEP’S SMALL BUSINESS ADVOCACY TEAM

TOP 3 Objectives

1. Promoting collaboration, partnerships and collective growth in the defence industry
2. Improving SME’s access to European and national tenders and raising awareness about available industry funding opportunities in defence.
3. Engaging with EU policymakers effectively to advocate for fair competition, address barriers, and access resources  to enable companies to expand cross-border and overcome barriers hindering access to internal markets of other Member States.

AALEP'S Small Business Advocacy Team will support EU small to medium enterprises (SMEs) and enhance their opportunities to operate and grow in the EU Defence industry sector.

The Advocacy Team will:

• elevate understanding and awareness of commonly reported issues and challenges
• influence EU Defence procurement policy to remove barriers to participation
• develop specific policies and programs to provide enhanced opportunities
• support improved communications and delivery of critical services from EU Defence.

The  AALEP Advocacy Team will primarily remain connected with SMEs through intermediaries, to deliver these key functions:

• consult with stakeholders to identify and understand issues
• engage with senior EU Defence officials to address identified and confirmed issues
• support education programs for delivery to EU Defence and industry stakeholders
• engage with other advocacy bodies to compare insights and align activities and efforts
• assist EU Defence to structure programs and activities to maximise SME opportunities
• communicate with stakeholders on details of activities, efforts, achievements and future plans.

Note

While Europe counts 2500 small and medium-sized enterprises (SMEs) specialising in niche military technologies, their growth is hindered by limited access to private funding. Yet SMEs are considered the backbone of defence supply chains.

Limited funding access

A study conducted by the European Commission showed that between 2021 and 2022, approximately 40 per cent of SMEs faced difficulties accessing finance. Many avoided equity financing, and nearly half refrained from seeking loans.

Factors such as lengthy procurement processes, complex regulations, and a lack of specialised funds exacerbate these challenges, leading to estimated equity and debt financing gaps of up to €4 billion.

While countries like France, Germany, and Spain show some activity in venture capital and private equity for defence, the EU lacks the comprehensive financial ecosystems of the US and UK, where extensive public programmes support innovative defence companies.

Helping SMEs thrive

Public sector involvement is crucial to bridging this gap. Initiatives such as the Defence Equity Facility aim to stimulate private investment by creating a dedicated ecosystem for defence finance, enabling SMEs to scale, innovate, and enhance the EU’s defence resilience.

An analysis by the Centre for European Policy Analysis (CEPA) comes to the same conclusion. While it cites concerns over the fragmented nature of Europe’s defence markets, it calls for improving access to private financing as a critical step in revitalising Europe’s defence sector.

The European Defence Industrial Strategy (EDIS), introduced in 2024, aims to address shortcomings by focusing on demand aggregation, industrial transformation, and private investment.

Key proposals include implementing the European Defence Investment Programme (EDIP), reducing administrative burdens to foster economies of scale, and mobilising private capital through changes in European Investment Bank lending policies.

Impact of private equity

The 2023 “Investing in Europe: Private Equity Activity” report by Invest Europe highlighted the resilience and ongoing appeal of the European private equity and venture capital sectors.

In 2023, private equity funds raised €133 billion, with € 37 billion invested in SMEs (representing 85 per cent of all private equity portfolio companies), supporting over 20.000 companies and nearly one million jobs.

Although investments stood at €40 billion in the first half of 2024 due to market challenges, venture capital grew by 26 per cent year-on-year, driven by investments in artificial intelligence (AI) and tech-focused start-ups.

Notably, private equity is starting to shift its stance towards defence. More investors are backing defence-related ventures, reflecting evolving attitudes towards environmental, social, and governance (ESG) standards.

Increased defence expenditure

This shift aligns with increasing defence expenditure across Europe. From the record €279 billion in 2023, to €326 billion in 2024, according to the latest report of the European Defence Agency (EDA).

EDA Chief Jiří Šedivý emphasised the importance of boosting European defence autonomy by reducing reliance on off-the-shelf equipment from outside the EU and increasing collaboration within the European Defence Technological and Industrial Base.

Although 20 Member States exceeded the investment benchmark of 20 per cent of total defence expenditure, innovation in defence research and technology remains a critical area for improvement to match global competitors like the US and China.

Private equity, combined with public initiatives like EDIS, holds the potential to transform Europe’s fragmented defence market by mobilising resources, driving innovation, and improving competitiveness, ultimately strengthening the EU’s military capabilities and strategic autonomy.