Resilient returns: how drive for defense autonomy is creating demand for private capital investment

Rapidly evolving geopolitical conflicts and the pivot towards greater strategic autonomy, particularly in Europe, are driving historic levels of spending on defense.

The U.S. defense budget rose over 7% to USD962 billion for 2026, with proposals to push it to USD1.5 trillion by 2027. NATO members have pledged to allocate 5% of their GDP to defense, while research from Carlyle suggests that European defense and infrastructure spending could reach EUR14tn over the next decade.

In response, an increasing number of private capital providers are loosening historic constraints to launch dedicated defense strategies.

Private equity investment in aerospace and defense hits new high

Private equity deal value in the aerospace and defense sector hit a record USD55.6bn in 2025. Public markets have followed: the Stoxx Europe Aerospace and Defense index has more than tripled since 2022.

This is a structural shift rather than a cyclical trend. Europe’s defense expansion is underpinned by political consensus across EU institutions and member states that strategic autonomy requires sustained industrial investment. Order backlogs at Europe’s largest defense companies have risen by around 15%, creating pressure to expand production capacity.

Meanwhile, EU industrial policy tools (including the Security Action for Europe (SAFE) funding program) are using public money to mobilize private capital as a core element of the buildout. This approach is further reinforced by the EU’s ReArm Europe strategy.

These trends present a significant and sustainable opportunity for private capital investors and for portfolio companies planning to enter the market, particularly those with technologies that have both civilian and military applications.

However, despite clear signals from policymakers in the U.S. and across Europe encouraging greater private capital participation in the sector, there are significant trade-offs that must be addressed, not least that defense is a complex, tightly governed industry, with extensive regulation and strict compliance obligations.

Why investing in defense assets is different

The emergence of specialist PE funds, defense-focused private credit vehicles and private capital firms entering into joint ventures with primes reflects growing institutional comfort with the sector.

However, investors new to the sector need to understand that defense investments are not like other deals. The defense industry operates under a unique set of economic, regulatory, and political rules with governments at the center: as customer, regulator, funder, and gatekeeper.

Revenues are often indirect, with government contracts held by prime manufacturers (e.g., Lockheed Martin, RTX, BAE Systems, Safran, Rheinmetall and Leonardo), and value flowing through tightly controlled supply chains.

In response, investors must build extensive relationships with primes, defense authorities, and local champions. They must also be prepared for sector-specific processes: long and sometimes opaque procurement cycles, states seeking broad rights over intellectual property, and extensive and closely audited compliance obligations throughout the supply chain; end-to-end traceability of components, stringent cybersecurity protections, auditability, certified quality management and lawful sourcing. Private capital investors must engineer compliance via flow-down clauses, verification rights and offset governance arrangements.

Deal processes face intense regulatory scrutiny

Defense M&A due diligence takes substantially longer than in other sectors, often requiring security clearances and multijurisdictional approvals. Foreign direct investment screening is intense. Government spending programs often impose minimum content requirements: Europe’s SAFE program, for example, aims to cap components sourced outside the EU and a subset of associated countries at 35% of contract value.

This creates structural disadvantages for non-EU-domiciled funds. Critically, it is not just where a fund is raised but where the investment committee sits and decisions are made that can determine eligibility.

Similar dynamics are at play in the U.S., where the federal administration is focused on onshoring defense supply chains. Here, the Department of War, through the Office of Strategic Capital, is expanding its budgetary and loan authority to support domestic manufacturing, particularly in critical minerals. A notable emerging structure involves government debt financing alongside private equity. However, this state money can carry conditions, including that products developed with public support must be dual- or multi-use.

ESG not the barrier to investment it once was

ESG considerations remain a source of debate: while both the UK's FCA and the EU have clarified that sustainability rules do not prevent defense investment, a NATO Innovation Fund study found exclusion policies still in place at 75 of Europe’s largest banks.

At the same time, the definition of “defense” itself is expanding. Dual-use technologies, critical infrastructure, and enabling capabilities (including AI, quantum, cybersecurity, drones, and semiconductors) are increasingly drawn into the defense perimeter. These assets are increasingly attractive to private capital sponsors, given that they lack the entrenched supplier relationships of traditional military domains and offer a larger pool of potential buyers outside of pure-play defense contractors.

Procurement dynamics create asset valuation challenges

Despite the trajectory of the sector, asset valuations are complicated by volatile procurement cycles. Sales pipelines can spike sharply with new orders and then flatten, so investors must time their entry and exit with care. Reputational risk is also a factor, as is litigation, which can arise from a variety of sources. Eligibility tests, local‑content rules, tighter foreign investment screening, and lengthy procurement and approval procedures add further complexities.

However, demand‑side signals from governments in the U.S., across the EU and beyond show a tangible commitment to strengthen defense spending and, crucially, to support the industry. To do so, private capital is increasingly recognized as essential by policymakers, regulators and the wider market.