Is it ethical for investors to bite the bullet and bet on future freedom?

In a world facing the combined evils of Russia, Iran and North Korea – and their non-state terrorist allies – should VC be playing its part by investing in defense startups?

WHAT IS “ETHICAL” INVESTING? Should investors only back projects that heal the sick, feed the hungry and cause no harm to anyone? Or should we also provide the resources to defend our freedoms against dictators and warmongers who threaten the security of the modern world?

In a world facing the combined evils of Russia, Iran and North Korea – and their non-state terrorist allies – should VC be playing its part by investing in defense startups? This is a timely question. “VC investors globally have shown an increasing interest in defensetech over the last few quarters,” KPMG notes in its Q2 2024 Venture Pulse Report . “In the US, a number of defensetech companies have scaled to a size where they can compete with defense industry incumbents for contracts.”

While it’s far from being a simple question, I think I know where I stand.

My first exit was a company called MERET (MEdved REsearch and Technology), founded by my late father Dr David Medved, that we sold to Amoco in 1990. MERET was a pioneer in fiber optic communications. It specialized in utilizing fiber communication for remote video displays, primarily for military applications. Our biggest customer was the US Army. Our systems helped guard US nuclear submarine pens, the national command center at Cheyenne Mountain in Colorado and several other complex military installations.

Not natural bedfellows

That early experience taught me a lot about military startups – and it wasn’t all positive. Many trace the birth of US venture capital to the $750 million invested by the US Department of Defense in research and development in the 1950s. Others believe that modern startup culture was created in large part by the offsite “skunkwork” innovation initiated by Lockheed Martin. But I saw that startups and the military are not natural bedfellows. While startups thrive on agility and speed, military systems and projects are characterized by bureaucratic processes, cumbersome paperwork and slow deployment.

After the sale of MERET, I moved to Israel, where the military plays a pivotal role in the startup ecosystem, from the nurturing of talent to the creation of new technologies that ex-defense forces entrepreneurs are encouraged to develop for the commercial market. Israel’s Startup Nation would not exist without the military and its elite units.

Since launching my VC career following that sale and other startup activity in the early 90s, I have learned to keep things lean, execute fast, and focus on commercial products rather than military startups. This approach chimes with Israel’s attitude to tech, led by the example of the Israel Innovation Authority, which invests directly in commercialized military technology spinoffs including cybersecurity, optics and robotics.

For the past 35 years, first at Israel Seed Partners and now at OurCrowd, I have led investments in pure technology companies, but also in startups pushing the frontiers of medicine, food, farming, water, alternative energy and climate technology. We didn’t need an ESG directive to champion what would become known as impact investing – doing good for the community while doing well for investors. It just made sense.

Survive

At the same time, living in Israel, constantly harassed by enemies pledged to its destruction and the mass murder or expulsion of its population, we did not hesitate to invest in technologies that might help us to survive in peace.

Even before 9/11 and the subsequent wars in Iraq and Afghanistan, Bruce Held and Ike Chang of the Rand Corporation proposed tapping venture capital to improve US military R&D.

“The Army must find better methods for developing the technologies needed to stage its revolution in military affairs while keeping current equipment relevant and affordable,” Held and Chang argued. “The Army should fund some of its technology development through a private venture capital organization. The concept exploits venture capital’s efficiency in developing technology, its access to the growing commercial technology sector, its capacity to respond with agility to changing technology, and its ability to leverage additional resources throughout the development cycle.”

Even as the rise of Al Qaida and Islamic State forced the free world to protect itself against lethal non-state actors, the Rand analysts’ suggestion was largely ignored

But since Russia’s invasion of Ukraine and the subsequent emboldening of the Russia-Iran-North Korea axis of autocracy, I sense a marked shift in sentiment among venture capitalists who have become aware of a compelling triptych: the investment opportunities available in the military market, the urgent need for private funding, and the ethical case for physical security alongside food, health and water security.

American Dynamism

Leading VCs including a16z, Sequoia Capital, SoftBank’s Vision Fund, Accel Partners, General Catalyst, and Naspers Ventures have led the injection of more than $100 billion into US defense technology companies since 2022, according to Outlander VC , a pre-seed fund led by Paige Craig, a US Marine Corps veteran and intelligence tech entrepreneur.

“Venture capital could be NATO’s ultimate weapon . Staying at the forefront of technological innovation is more important than ever in securing the future of 1 billion citizens of NATO members by boosting the nations’ readiness in these turbulent times,” write Klaus Hommels, Chair of the NATO Innovation Fund and Founder and Chairman of Lakestar, and Fiona Murray, Vice Chair of the fund and Associate Dean of Innovation at MIT School of Management. “Not only is it necessary for our security, resilience, and ultimately, prosperity but it also makes good business sense.”

Andreessen Horowitz/a16z, a leader of this new venture activity, describes it as “American Dynamism ,” investing in “founders and companies that support the national interest” where “mission-driven and civic-minded founders often build companies that transcend verticals and business models in their quest to solve important national problems. These companies view the government as a customer, competitor, or key stakeholder.”

However the ethics of defense tech and the balance between security and morality can be hard to navigate.

“Events of the past few years have served as a wake-up call that for all of our efforts to build an international order that prizes peace, the world remains a dangerous place, and that we cannot take America’s security for granted.?Our security and our welfare require intentional investment and production,” says Andrew Glenn , a venture capitalist with extensive experience in the aerospace and defense sectors. “There are options for those that wish to support national security and the defense of the globally accepted, classically liberal order while observing the sensitivities about potential harm caused from our work.”

Strategic exceptions

Following Russia’s invasion of Ukraine, European banks long opposed to investment in defense companies, including SEB in Sweden and the French Banking Federation, are now looking at strategic exceptions.

“We would not be at all surprised if a certification were to arise incorporating defense-tailored ESG criteria,” says Xavier de Laforcade , Partner and Head of Portfolio Management at Rothschild Martin Maurel, noting SEB’s finding that “investments in the defense industry are critical to supporting and defending democracy, freedom, stability and respect for human rights.”

The accepted definition of ESG is undergoing a fundamental change. Investors are shifting toward the view that good governance is useless without the basic security that your economy will not be destroyed by another country invading your territory or capturing your resources.

“Defense is likely to be increasingly seen as a necessity that facilitates ESG as an enterprise as well as maintaining peace and stability and other social goods,” say Citi analysts .

In the US, venture investors have enabled defense-related companies like Anduril and Palantir to set the course for small successful startups to become very big, very quickly. They represent a merger of startup speed and growth with the need for strong military capability.

Some investors are dipping their toe in the water by backing dual-use or non-lethal technologies, but still shying away from investing in defense systems that can directly kill people. While this may allow some investors to feel more comfortable, it’s a bit like investing in a car but refusing to invest in the wheels.

Game Theory

Professor Yisrael Aumann, my neighbor here in Jerusalem, explains Game Theory for which he won the Nobel Prize with a story about hiking with his grandson in Switzerland. They were climbing a mountain when a formation of fighter jets flew low overhead. “Whose planes are those?” Asked his grandson. “The Swiss Air Force,” Aumann replied. “But Switzerland is neutral and doesn’t fight wars. Why does it have an air force?” His grandson inquired. “It has an air force so it can remain neutral and never have to fight,” Aumann responded.

Personally, I would prefer if every country was like Switzerland, where we were armed to the teeth, but had no wars and my kids did not have to fight in combat. But unless we defend our free societies from those who seek to destroy them, unless we take the steps to be ready and prepared, our free societies ?are doomed. Forced into battle, I want our kids to have the best protection and most accurate weapons to help ensure they eliminate the monsters without harming innocent bystanders.

The democratic world is engaged in a struggle against armed dictators who invade our countries, kill our people and threaten the stability of the entire planet. We need to think less about dual use than duel use.

Relevant investments in the OurCrowd portfolio include Edgybees , mPrest , Harpoon Ventures and Airobotics , which recently demonstrated Iron Drone – a reusable UAV interceptor and possible solution to the plague of killer drones launched by Russia, Iran, Hezbollah and Houthi forces in Yemen.

Our defense industries are crying out for the capital and capabilities of VC investors to develop the tools of modern warfare we sadly require. By seizing these opportunities, investors might enjoy some outsized returns. We might also help secure a world safe and peaceful enough to enjoy them.

About ‘Investors on the Frontlines’

I’m the CEO and Founder of?OurCrowd , the global equity investment platform that gives individual accredited investors access to pre-IPO startup deals alongside top-tier VCs. If you are an investor, private family office or financial advisor, subscribe?here ?for my biweekly commentary or follow me on?Twitter . I welcome your comments in the response section below.

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