HOW TO BECOME A UNICORN IN DEFENSE

Unicorns are a rare species in the defense industry. Reaching that mythical $1 billion valuation is incredibly difficult in any industry, but the defense industry comes with its own unique challenges. A small number of big players, such as Lockheed Martin, Raytheon Technologies, Boeing and Northrop Grumman, dominate the industry and capture most of the high-value government contracts. This market entrenchment goes back several decades but has in recent years reached extraordinary proportions. Nevertheless, times seem to be changing as a new wave of smaller companies manages to make inroads in this highly monopolised industry. Specifically, four US defense technology startups have reached unicorn status over the past three years: Anduril Industries, Epirus, Rebellion Defense and Shield AI. The four companies follow in Palantir Technologies and SpaceX’s footsteps, reaching unicorn status more than ten years ago.

The sudden emergence of defense unicorns is driven by unprecedented interest of venture capital firms in the defense industry. Amidst growing geopolitical competition and uncertainty, investing in national security is increasingly seen as a moral imperative rather than a taboo. Prominent Silicon Valley VC firms such as Andreessen Horowitz, Founders Fund and Lux Capital recognise the potential of private defense companies to tap into the $813 billion US Department of Defense (DoD) budget (as of 2022). The success of Anduril, Epirus, Rebellion and Shield AI can largely be attributed to their strong focus on artificial intelligence and specific emerging technologies that meet the future needs of the military.

Anduril and Shield AI build autonomous systems that can be used for surveillance in contested environments. Epirus develops directed energy microwave weapons that function as counter uncrewed aerial systems (CUAS). Rebellion Defense is a software company building AI solutions for battlespace awareness, autonomous missions and cybersecurity. The DoD and other defense departments of other countries consider each of these capabilities a critical priority to prevail in 21st-century warfare. As a result, significant funding is flowing in this direction. The question is, how can the four defense unicorns serve as a blueprint for other defense startups? To answer this question, we take a closer look at five key success factors:

The Valley of Death
Artificial Intelligence for Defense
Rapid Development and Scaling
Partnerships and Acquisitions
International Expansion

1. The Valley of Death

A significant obstacle for startups in the defense industry is the acquisition process of the DoD. Promising companies often fail to move beyond the research and development (R&D) phase because it takes too long to secure a production contract. In US defense circles, this is called the Valley of Death. More than 80 per cent of new entrants exit the defense market before obtaining recurring revenue. Self-financing is one way to bridge the Valley of Death. Anduril co-founder and billionaire Palmer Luckey self-funded the company in its R&D phase. Pioneering defense unicorns Palantir and SpaceX were founded by billionaires – Peter Thiel and Elon Musk, respectively.

In the absence of a billionaire founder, a more realistic option is to attract sustained venture capital investments until the company wins substantial contracts. Epirus, Rebellion, Shield AI and many other defense startups follow this model. To succeed, the company founders must convince investors that they can compete with established defense contractors and that their products meet DoD requirements and regulations. Defense startups also benefit from prototyping contracts with government institutions such as the DoD’s Defense Innovation Unit (DIU) and the US Air Force’s AFWERX. These contracts signal to VC investors that companies have a way into bigger DoD opportunities as well as the opportunity to develop prototypes with organisations that can become future clients. Industry and government leaders are also working to speed up the acquisition process, a critical priority to ensure defense innovation.

2. Artificial Intelligence for Defense

Artificial intelligence (AI) is widely recognised as a critical technology in defense as it will enable militaries to operate more efficiently, effectively and at far greater speed and scale. The four defense unicorns develop and deploy AI software as an integral part of their products. They were first-movers in developing cutting-edge Silicon Valley-level AI and applying it to the national security mission. By deploying AI in defense hardware, startups can gain an edge over competitors.

Anduril’s autonomy software, Lattice OS, uses AI, edge computing and sensor fusion to detect, track and classify objects of interest. Epirus created the world’s first software-defined electromagnetic pulse. The innovation is integrating AI-enhanced smart chips into microwave weapons, enabling a much more efficient and powerful beam. Shield AI’s Hivemind is the leading autonomy software for coordinating drone swarms. AI also runs at the core of Rebellion’s data analytics offerings used for battlefield situational awareness.

3. Rapid Development and Scaling

While traditional defense contractors take many years to develop and improve products, startups can adopt a more agile approach of rapid prototyping and scaling. For example, Rebellion adopts a commercial sector agile software development approach that prioritises speed and can be scaled rapidly. Successful defense startups also often use commercial off-the-shelf (COTS) hardware to speed up development timelines, cut costs and scale rapidly. Anduril uses COTS parts to build aerial and underwater vehicles, and Epirus uses COTS semiconductors for its directed energy weapons. Epirus made a directed energy weapon in nine months, much quicker than defense prime competitors. The benefit of rapid development and scaling is lower costs. It also signals to investors and DoD decision-makers that the company can deliver quickly.

4. Partnerships and Acquisitions

Partnerships and acquisitions are common strategies to increase a company’s market share and growth. Defense startups can partner with large defense contractors or companies to gain wider market access. For example, Epirus partnered with General Dynamics and Northrop Grumman to offer integrated C-UAS solutions. Shield AI has partnered with Textron Systems to integrate its autonomy software into Textron’s platforms. By and large, however, the four defense unicorns have mainly focused on their own capabilities rather than seeking partnerships.

As startups attract investment, they can acquire other companies to spur growth and enhance vertical or horizontal integration. Of the four defense unicorns, only Anduril and Shield AI have used this strategy. Anduril acquired Area-I in 2021 and Dive Technologies in 2022. Area-I is a leader in tube-launched autonomous UAVs, and Dive Technologies is a leader in autonomous underwater vehicles. Anduril will integrate the platforms into its autonomy software, Lattice OS. With the acquisitions, Anduril expands its share of the autonomous systems market. Shield AI acquired software autonomy company Heron Systems and Martin UAV, a leader in vertical takeoff and landing (VTOL) UAVs, in 2021. Shield AI will integrate its autonomy software, Hivemind, into Martin UAVs V-BAT, reinforcing Shield AI’s strong market position in the autonomous UAV market.

5. International Expansion

Expanding into new geographic markets is a common strategy to increase company revenue and growth. International expansion facilitates product sales for defense companies in important hubs outside of the US. Of the four defense unicorns, Epirus is the only company that has not yet expanded internationally. Founded in 2017, Anduril opened offices in London and Australia in 2020 and 2022. Anduril partners with the Australian Defence Force to build autonomous underwater vehicles. Rebellion also has offices in the US and London. Founded in 2015, Shield AI opened its first international office in 2022 in Abu Dhabi, a booming defense hub.

The Defense Unicorn Roadmap

The success of Anduril, Epirus, Rebellion and Shield AI can serve as a blueprint for other defense startups pursuing unicorn status. Most importantly, startups need to bridge the Valley of Death, leverage AI and enable rapid development and scaling. Partnerships, acquisitions and international expansion also contribute to startup growth albeit to a lesser extent than the first three factors. However, following the path of the four defense unicorns is no guarantee for success. The road to unicorn status in defense is dependent on many more variables, including internal factors such as team and company vision and external factors such as industry growth/trends and competition.

There are many promising defense startups with potential to reach unicorn status. At RAIN, we expect three defense companies to reach unicorn status within the next year: HawkEye 360, a geospatial intelligence company; Saildrone, an autonomous surface vehicle developer; and Echodyne, a company revolutionising radar technology. HawkEye 360, Saildrone and Echodyne effectively leverage AI, partnerships as well rapid development and scaling.

At RAIN Research, we have mapped 150 VC-backed defense startups in the first comprehensive report on venture capital involvement in the US defense sector. The report offers detailed profiles of 40 VC firms and 150 companies, with detailed analysis of investments and trends. Click on the image to the right to find out more, and access a free report brief.