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Two of three European defence "unicorns" are German

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Government more supportive of defence startups, CEOs say

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Govt creating fast track to bypass procurement red tape,

sources

say

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Smaller firms advising govt alongside Rheinmetall, source

says

By Supantha Mukherjee, Sarah Marsh and Christoph Steitz

MUNICH/BERLIN/FRANKFURT, July 23 (Reuters) - For

Gundbert Scherf - the co-founder of Germany's Helsing, Europe's

most valuable defence start-up - Russia's invasion of Ukraine

changed everything.

Scherf had to fight hard to attract investment after

starting his company - which produces military strike drones and

battlefield AI - four years ago.

Now, that's the least of his problems. The Munich-based

company more than doubled its valuation to $12 billion at a

fundraising last month.

"Europe this year, for the first time in decades, is

spending more on defense technology acquisition than the U.S.,"

said Scherf.

The former partner at McKinsey & Company says Europe may be

on the cusp of a transformation in defence innovation akin to

the Manhattan Project - the scientific push that saw the U.S.

rapidly develop nuclear weapons during World War Two.

"Europe is now coming to terms with defense."

Reuters spoke to two dozens executives, investors and

policymakers to examine how Germany - Europe's largest economy -

aims to play a central role in the rearming the continent.

Chancellor Friedrich Merz's government views AI and start-up

technology as key to its defence plans and is slashing

bureaucracy to connect startups directly to the upper echelons

of its military, the sources told Reuters.

Shaped by the trauma of Nazi militarism and a strong postwar

pacifist ethos, Germany long maintained a relatively small and

cautious defence sector, sheltered by U.S. security guarantees.

Germany's business model, shaped by a deep aversion to risk,

has also favoured incremental improvements over disruptive

innovation.

No more. With U.S. military support now more uncertain,

Germany - one of the biggest backers of Ukraine - plans to

nearly triple its regular defence budget to around 162 billion

euros ($175 billion) per year by 2029.

Much of that money will go into reinventing the nature of

warfare, the sources said.

Helsing is part of a wave of German defence start-ups

developing cutting-edge technology, from tank-like AI robots and

unmanned mini-submarines to battle-ready spy cockroaches.

"We want to help give Europe its spine back," said Scherf.

Some of these smaller firms are now advising the government

alongside established firms - so-called primes such as

Rheinmetall and Hensoldt - that have less

incentive to focus primarily on innovation, given their long

backlogs for conventional systems, one of the sources said.

A new draft procurement law, expected to be approved by

Merz's cabinet on Wednesday, aims to reduce hurdles for

cash-strapped start-ups to join tenders by enabling advance

payment to these firms, according to a version dated June 25,

reviewed by Reuters.

The law would also entitle authorities to limit tenders to

bidders inside the European Union.

Marc Wietfeld, CEO and founder of autonomous robots maker

ARX Robotics, said a recent meeting with German defence minister

Boris Pistorius hammered home how deep the rethink in Berlin

goes.

"He told me: 'Money is no longer an excuse - it's there

now'. That was a turning point," he said.

GERMANY IN THE LEAD

Since Donald Trump's return to the political stage and his

renewed questioning of America's commitment to NATO, Germany has

committed to meet the alliance's new target of 3.5% of GDP on

defense spending by 2029 - faster than most European allies.

Officials in Berlin have emphasized the need to foster a

European defence industry rather than rely on U.S. companies.

But the hurdles towards scaling up industry champions in Germany

- and Europe more broadly - are considerable.

Unlike in the United States, the market is fragmented in

Europe. Each country has its own set of procurement standards to

fulfill contracts.

The United States, the world's top military spender, already

has an established stable of defence giants, like Lockheed

Martin ( LMT ) and RTX, and an advantage in key areas, including

satellite technology, fighter jets and precise-guided munitions.

Washington also began boosting defence tech startups in 2015

- including Shield AI, drone maker Anduril and software company

Palantir ( PLTR ) - by awarding them parts of military contracts.

European startups until recently languished with little

government support.

But an analysis by Aviation Week in May showed Europe's 19

top defence spenders - including Turkey and Ukraine - were

projected to spend 180.1 billion this year on military

procurement compared, to 175.6 billion for the United States.

Washington's overall military spending will remain higher.

Hans Christoph Atzpodien, head of Germany's security and

defence sector association BDSV, said one challenge was that the

military's procurement system was geared toward established

suppliers and not well suited to the fast pace that new

technologies require.

Germany's defence ministry said in a statement it was taking

steps to accelerate procurement and to better integrate startups

in order to make new technologies quickly available to the

Bundeswehr.

Annette Lehnigk-Emden, head of the armed forces' powerful

procurement agency, highlighted drones and AI as emerging fields

that Germany needs to develop.

"The changes they're bringing to the battlefield are as

revolutionary as the introduction of the machine gun, tank, or

airplane," she told Reuters.

SPY COCKROACHES

Sven Weizenegger, who heads up the Cyber Innovation hub, the

Bundeswehr's innovation accelerator, said the war in Ukraine was

also changing social attitudes, removing a stigma towards

working in the defence sector.

"Germany has developed a whole new openness towards the

issue of security since the invasion," he said.

Weizenegger said he was receiving 20-30 Linkedin requests a

day, compared to maybe 2-3 weekly back in 2020, with ideas for

defence technology to develop.

Some of the ideas under development feel akin to science

fiction - like Swarm Biotactics' cyborg cockroaches that are

equipped with specialised miniature backpacks that enable

real-time data collection via cameras for example.

Electrical stimuli should allow humans to control the

insects' movements remotely. The aim is for them to provide

surveillance information in hostile environments - for example

information about enemy positions.

"Our bio-robots - based on living insects - are equipped

with neural stimulation, sensors, and secure communication

modules," said CEO Stefan Wilhelm. "They can be steered

individually or operate autonomously in swarms.

In the first half of the 20th century, German scientists

pioneered many military technologies that became global

standards, from ballistic missiles to jet aircraft and guided

weapons. But following its defeat in World War II, Germany was

demilitarized and its scientific talent was dispersed.

Wernher von Braun, who invented the first ballistic missile

for the Nazis, was one of hundreds of German scientists and

engineers transported to the United States in the wake of World

War II, where he later worked at NASA and developed the rocket

that took Apollo spacecraft to the Moon.

In recent decades, defence innovation has been a powerful

driver of economic progress. Tech like the internet, GPS,

semiconductors and jet engines originated in military research

programs before transforming civilian life.

Hit by high energy prices, a slowdown in demand for its

exports and competition from China, Germany's $4.75 trillion

economy contracted over the last two years. Expanding military

research could provide an economic fillip.

"We just need to get to this mindset: a strong defense

industrial base means a strong economy and innovation on

steroids," said Markus Federle, managing partner at

defence-focused investment firm Tholus Capital.

ESCAPING 'THE VALLEY OF DEATH'

Risk aversion among European investors had in the past

disadvantaged startups, which struggled to get the capital they

need to survive the 'valley of death' - the critical early stage

when costs are high and sales low.

But a boost in defence spending by European governments

following Russia's invasion of Ukraine has investors looking for

opportunities.

Europe now boasts three start-ups with a unicorn valuation

of more than $1 billion: Helsing, German drone maker Quantum

Systems, and Portugal's Tekever, which also manufactures drones.

"There's a lot of pressure now on Germany being the lead

nation of the European defense," said Sven Kruck, Quantum's

chief strategy officer.

Germany has become Ukraine's second-biggest military backer

after the United States. Orders that might once have taken years

to approve now take months and European startups have had the

opportunity to test their products quickly in the field, several

sources said.

Venture capital funding of European defence tech hit $1

billion in 2024, up from a modest $373 million in 2022, and is

expected to surge even more this year.

"Society has recognized that we have to defend our

democracies," said Christian Saller, general partner at HV

Capital, an investor in both ARX and Quantum Systems.

Venture capital funding has grown faster in Germany than

elsewhere, according to a data analysis by Dealroom for Reuters.

German defence startups have received $1.4 billion in the last

five years from investors, followed by UK, the data shows.

Jack Wang, partner at venture capital firm Project A, said

many German defence startups - rooted in the country's

engineering prowess - are good at integrating established

components into scalable systems.

"Quality of talent in Europe is extremely high, but as a

whole, there's no better country, no better talent that we've

seen other than in Germany," he said.

Weakness in Germany's automotive industry means there is

production capacity to spare, including in the Mittelstand: the

small and medium-sized enterprises (SMEs) that form the backbone

of Germany's economy.

Stefan Thumann, CEO of Bavarian startup Donaustahl, which

produces loitering munitions, said he receives 3 to 5

applications daily from workers at automotive companies.

"The startups just need the brains to do the engineering and

prototyping," he said. "And the German Mittelstand will be their

muscles."

($1 = 0.8560 euros)