Private Capital Perspectives

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

Geopolitical volatility and the desire for defense resilience are creating a powerful new investment cycle, with governments looking to mobilize private capital to scale industrial capacity, particularly in dual-use and technology-led assets. But this is not a conventional market: complex regulation, political oversight and constrained deal dynamics demand a fundamentally different approach from investors seeking to participate.

BY MAGDA NASILOWSKA, HENDRIK ROEHRICHT AND JEAN LEE

SUMMARY

• FDI screening requirements vary by jurisdiction, with regulators in the U.S., UK, EU, Spain, and Australia enforcing strict controls on foreign investments in businesses with defense applications.
• National regulations often capture minority stakes and may require remedies such as co-investors, firewalls, or nationality restrictions for directors to protect sensitive information and assets.
• Investors should conduct rigorous early self-assessment of regulatory requirements and develop sophisticated government affairs strategies, as regulators may scrutinize fund structures and underlying limited partners.

Rapidly evolving geopolitical conflicts and the pivot towards greater strategic autonomy, particularly in Europe, are driving historic levels of spending on defense.In the U.S., the FDI screening process is administered by the Committee on Foreign Investment in the United States (CFIUS), which has broad authority to review transactions that could result in foreign control of a U.S. business.

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 intojoint 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 (FDI) 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.

What defense investors need to know about FDI and antitrust screening regimes

Defense deals are subject to overlapping regulatory screening regimes, each with distinct triggers and remedies. Here we explore how early regulatory mapping, coordinated filings and carefully calibrated deal terms are critical to navigating an approval landscape that is both complex and increasingly interventionist.

BY DANIEL HARRIS, CATHERINE HEIN, DOMINIC LONG, FRANCESCA MIOTTO, KEN RIVLIN, JAMES FORD AND MARIO GARCIA

SUMMARY

• FDI screening requirements vary by jurisdiction, with regulators in the U.S., UK, EU, Spain, and Australia enforcing strict controls on foreign investments in businesses with defense applications.
• National regulations often capture minority stakes and may require remedies such as co-investors, firewalls, or nationality restrictions for directors to protect sensitive information and assets.
• Investors should conduct rigorous early self-assessment of regulatory requirements and develop sophisticated government affairs strategies, as regulators may scrutinize fund structures and underlying limited partners.

The acquisition of an interest in defense or dual-use businesses could trigger reporting and approval requirements under applicable FDI regimes, depending on the nature and level of investment. FDI reviews consider whether a transaction could pose national security risks, including in relation to the reduction of critical capabilities and the leakage of classified information.

In the U.S., the FDI screening process is administered by the Committee on Foreign Investment in the United States (CFIUS), which has broad authority to review transactions that could result in foreign control of a U.S. business.

CERTAIN NON-CONTROLLING BUT NON-PASSIVE INVESTMENTS IN SCOPE FOR CFIUS

CFIUS screening also applies to certain non-controlling but non-passive investments in “TID U.S. businesses” (which involve critical technologies, covered investment critical infrastructure (e.g., critical telecommunications, financial systems etc.) or sensitive personal data), and transactions that involve real estate in proximity to certain U.S. government and military facilities. A CFIUS filing may be mandatory when a foreign investor acquires an interest in a TID U.S. business.

The Defense Counterintelligence and Security Agency (DCSA) addresses FOCI (foreign ownership, control or influence) when a foreign person has the power, directly or indirectly (whether exercised or not) to direct or decide matters affecting the management or operations of a U.S. company that possesses a facility clearance, classified information, or classified contracts (we explore the issues surrounding classified information and security clearances in more detail here). A U.S. company determined to be under FOCI is unable to perform classified work unless and until effective security measures have been put in place to negate or mitigate FOCI to the satisfaction of the DCSA.

The International Traffic in Arms Regulations (ITAR), administered by the Directorate of Defense Trade Controls (DDTC) within the U.S. Department of State, impose specific requirements (including registration) on U.S. companies that manufacture, export, or broker defense articles, defense services, or related technical data listed on the United States Munitions List (USML). When there is a material change in registration information, or a foreign person or entity acquires ownership or control of a DDTC-registered company, the company must notify the DDTC in writing.

UK REGULATIONS IMPOSE MANDATORY REPORTING REQUIREMENTS

In the UK, the National Security and Investment Act (NSIA) governs the screening of foreign (and domestic) investments in sensitive sectors. Certain acquisitions of targets that deal in or manufacture defense items fall within the scope of reporting requirements under the NSIA and are subject to mandatory notification to, and prior clearance by, the UK government, coordinated through the UK’s Investment Security Unit. Transactions that do not obtain requisite clearance in advance are deemed legally void in the eyes of the UK courts, with acquiring parties potentially subject to fines, and in certain circumstances, criminal sanctions. Transactions considered to give rise to a risk to UK national security may be unwound if already completed, cleared subject to remedies or prohibited.

In the European Union, Regulation (EU) 2019/452 establishes a cooperation and coordination framework for the screening of FDI on security or public order grounds, which specifically includes defense and dual-use items such as AI, quantum computing and semiconductors. Screening decisions remain the exclusive competence of member states, but the regulation enables the Commission and other EU countries to review and comment on transactions that raise cross-border concerns. In response to the regulation, all member states have incorporated FDI screening mechanisms into their national legislation. Failing to comply with the applicable requirements could result in transactions being prohibited or unwound.

MANY EU MEMBER STATES’ RULES CAPTURE MINORITY INVESTMENTS

Across EU member states, many national screening protocols capture minority stakes. Spain for example has a dedicated defense FDI regime triggered at a 5% ownership threshold that is applicable to any non-Spanish investor, including EU nationals. The Spanish government may impose a diverse range of remedies in defense transactions, including requiring foreign buyers to accept Spanish co-investors, implement firewalls to protect sensitive information or assets, and mandating that directors be Spanish nationals.

In Australia, the country’s Foreign Investment Review Board (FIRB) conducts enhanced reviews of overseas investments into businesses with defense or military applications, particularly for foreign-government-linked investors. Here, a mandatory notification and approval may be required prior to acquiring stakes as low as 10%, with no minimum dollar investment threshold, and for certain investors prior to starting a business which proposes to operate in the defense space.

The identity of private equity funds’ limited partners presents a potential regulatory obstacle. Many FDI regulators look through a fund’s structure to examine the nationality and profile of underlying LPs, on the basis that those providing capital may exercise influence regardless of formal voting rights.

EARLY ASSESSMENT OF POTENTIAL RISKS IS VITAL FOR INVESTORS

Investors exploring opportunities in the defense sector should conduct early, rigorous self-assessment via scoping out likely FDI requirements and modeling the range of possible outcomes, including governance restrictions that may limit synergies or information flow. Particularly in the U.S., a sophisticated government affairs strategy, including lobbyists engaged before the deal, has become a feature of the market under the current administration.

Conditionality in transaction documents must be carefully drafted: hell-or-high-water clauses applying to FDI notifications are generally resisted by acquirers given the unpredictability of government-imposed conditions, and sellers and buyers must negotiate how to distribute regulatory uncertainty accordingly. Investors must also think about their exit options from the outset; the pool of eligible buyers for businesses considered relevant to national security is likely to be narrower than in other sectors, with FDI restrictions imposing an additional hurdle. As a result, we are seeing increasing interest in public listings as an exit option, an issue we explore in more detail here.

MERGER CONTROL PROCESSES ADD FURTHER COMPLEXITY

Alongside FDI screening, merger reviews and, in the EU, the Foreign Subsidies Regulation (FSR), may also be applicable.

For private capital investors, merger control assessments may apply to firms pursuing bolt-on strategies. At one level, defense deals are assessed like any other transaction, with antitrust authorities focused on the impact of transactions on competition.

However, in Europe the focus on defense preparedness has seen the EU Commission become more receptive to arguments about resilience when analyzing deals (i.e., also considering the impact of transactions on the robustness of the European defense supply chain, access to key inputs and the ability of companies to withstand shocks).

The Commission is currently conducting a review of its merger guidelines, with competitiveness, innovation and supply chain resilience identified as core themes.

The recently published draft revised guidelines go further than prior practice by explicitly recognizing that, in certain circumstances, consolidation may contribute to security of supply, industrial scale and the ability of European firms to compete effectively in global and technologically dynamic markets, including in strategically sensitive sectors such as defense.

This represents a shift in emphasis from the traditional framework, under which such considerations were primarily assessed as efficiencies invoked to rebut identified harm. While the draft guidelines do not change the underlying legal standard, they suggest a more integrated approach in which potential pro-competitive effects are assessed alongside theories of harm as part of the overall competitive analysis.

As we explored in our recent alert, this evolution may allow parties to proactively frame transactions in terms of their contribution to scale, innovation and resilience, rather than relying on these arguments only at a later stage.

With that said, merger assessments remain anchored in established principles, and the Commission continues to require robust, verifiable evidence demonstrating that any claimed benefits are merger-specific and sufficient to offset a reduction in competition. In practice, the evidentiary bar remains high.

In defense transactions, this evolving approach is also reflected in longer pre-notification phases and earlier engagement on potential remedies, particularly where markets are already concentrated and/or strategic capabilities or supply chains are at issue.

In In the U.S., the Hart-Scott-Rodino merger filing process underwent a significant overhaul in early 2025 with the introduction of a revised form that required substantially more information than under the previous regime.

Earlier this year the old, shorter form was temporarily reintroduced as the Federal Trade Commission (FTC) appealed a lower court decision that it had overstepped its rulemaking authority.

At the same time, merger filings for qualifying transactions (which include some technology deals) are now sent to the Department of War as well as being reviewed by the Department of Justice and FTC. It is not yet clear how the DOW uses the information it receives.

GLOBAL COORDINATION ACROSS APPLICABLE REGIMES IS CRITICAL TO SUCCESSFUL EXECUTION

The FSR review process is designed to investigate and counteract distortive subsidies granted by non-EU governments. The term “foreign subsidy” covers any financial contribution from a non-EU government or public entity that confers a selective benefit on a business operating within the EU single market. “Financial contributions” is defined broadly to include grants, loans, tax incentives and even the provision of goods or services at market terms.

FSR mandates pre-notifications for large mergers (where the target or one of the merging parties has a turnover within the EU of more than EUR500m and the parties received combined foreign financial contributions (FFCs) of more than EUR50m in the previous three years) and significant public tenders (more than EUR250m in contract value, with the bidder receiving FFCs exceeding EUR4m).

Against this backdrop, global coordination is critical: FDI, merger control and FSR filings across jurisdictions must not fall out of step, and remedies across regimes and countries must be aligned.

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