The small Baltic nation is rapidly innovating under threat from Russia, but more sophisticated investors and an easier procurement system are needed to take its defence sector further.
Since Russia’s full-scale attack on Ukraine, Estonia has been scrambling to strengthen its defence sector. Though it has a population of just 1.3 million, and a landmass roughly the size of Denmark, the small Baltic nation has been able to turn to its thriving tech scene, where private and public capital has mobilised to establish a new generation of defence startups.
The change in investor psychology has been dramatic. Back in 2017, Marek Alliksoo struggled to find backers for his startup SKYCORP Technologies, a dual-use hydrogen-powered drone company, with uses for energy infrastructure security and demining, among other things.
“Then 2022 happened,” he says. “Suddenly, everybody started to understand what we were talking about all those years ago.”
Just this year, Enterprise Estonia, a government agency, announced a round of grant funding for defence startups. SmartCap, the country’s sovereign fund, committed to making investments of between €5m and €20m in up to four defence-focused funds with an Estonian presence, and this month announced it had invested €10m in one of these, called Darkstar. There will in theory be plenty of demand for new defence tech solutions. Estonia’s defence budget currently stands at 3.3% of GDP, and is set to rise to 5% in 2026.
But while more VC funding is welcome, startup leaders argue that more than just money is needed to make the defence tech sector successful.
The influx of cash into a sector still in its infancy risks drawing in the wrong kind of investor. Erik Kannike, chief strategy officer of SensusQ, an Estonian data intelligence startup, says that the difficulty for his company has not so much been securing funding but rather ensuring that prospective investors knew what they were doing, and were not just dilettantes jumping in on the hype.
“You don’t want someone like that on your cap table, because defence is a serious business,” says Kannike. “If you’re selling to the government, they are going to ask about who are your shareholders.”
Given the paucity of experienced investors, Kannike says defence startups are in a “difficult situation.”
“You have to be very picky, but you don’t have a lot of choice.”
A common criticism of generalist VC investors moving into the sector is that they try to impose a rapid software-style growth strategy onto defence startups that need longer development cycles. Defence products have to be tested to destruction, adapted so they can integrate into the buying military, and then are often left hanging even longer while they wait for the government’s procurement cycle to finally roll around.
Maarja Pehk, head of investor relations in the UK for Enterprise Estonia, told GCV that she thinks corporate venture investment could “really come into play” here.
“Deep tech hardware verticals where the cycle is much longer than your traditional kind of VC startup really benefits from investors that understand that it takes time to develop a product and polish it to the level [where] it’s usable and useful,” she says.
An appetite for new technology
That lengthy cycle speaks to another challenge. In common with almost all countries, selling to the defence ministry as an unproven startup can be a long process.
Alliksoo, of SKYCORP, says that he believes the Estonian government has made strides towards making procurement quicker, but that it is still far inferior to Ukraine, which under the pressure of war has developed an exceptionally fast process for turning new tech ideas into functioning products in a less rigid system where individual brigades can put in orders. But if the Estonian Navy, for example, wants to do more than a small pilot of SKYCORP’s water-based drone systems, it cannot do so directly, and has to send the company through the government’s central procurement agency, with its standardised bureaucratic structure.
“Estonia is very good at making fast changes when needed,” he says. “[But] it’s still not like in Ukraine. What’s very advantageous [there] is the decentralised system. But none of the governments outside [Ukraine] have really done it yet, or cracked the way that defence procurement should work to be really [effective].”
However, Nicholas Nelson, general partner at Archangel, an Estonian defence tech fund, says that it is easier to sell to the country’s military than those in other European countries. Because Estonia does not have a large homegrown defence prime that it relies on for most of its supply – as many western European countries do – its ministry of defence, like those in other Baltic nations, has a larger appetite for new technology.
As startups don’t have to partner with defence primes to make a sale, they also don’t have to share contract revenue, another attraction of the region.
“I think it is a lot harder, as some of the more well-capitalised scale ups are finding out, to go into these really large markets [in western Europe] without having to basically take a massive haircut on your margins,” he says.
The roots of the latest Estonian defence tech wave
Estonia was poised to establish a new defence tech scene quickly. For one thing, it could draw on its well developed tech roots. It was Estonian programmers who developed the proprietary software for the telecoms company Skype, for example. Pehk, of Enterprise Estonia, points out that the country has more unicorns per capita than any other in Europe – such as the ride-hailing service Bolt.
And since the country regained its independence after the fall of the Soviet Union, there has always been a deep distrust of Russia. Marek Alliksso says that the 2014 invasion of Crimea was a wake up call that most of Europe failed to pay attention to, but in Estonia the prevailing belief was that “[Russia] never changed.” In 2007, the country faced a devastating cyberattack, which officials have accused the Kremlin of being behind.
Kannike, of SensusQ, says that the transition to defence tech was made easier in part by how integrated the military is in society, with conscription for men aged 18 to 27 for up to 11 months of service.
“We’re a tech heavy country. A lot of the same young men are going to study it. They’re going to be building CRMs, e-commerce, stuff like micro mobility,” he says.
“When everyone says, ‘Ok, we need to do something to defend ourselves,’ the same people that have software skills, firmware skills, they have a shared understanding [from] being in the military. They understand the context.”
Tech prowess, conscription and engineering skills from the universities are strong ingredients for the latest wave of defence startups. Many look like they are following the earlier example of Milrem robotics, a company founded in 2013 that makes autonomous ground combat vehicles. It was sold to Edge Group, a UAE defence company, in 2023. Milrem, as many Estonian defence tech startups are now doing, tested its weapons on the battlefield in Ukraine.
Frankenburg Technologies, which was founded last year, is also drawing on engineering innovation. It is trying to build cheap air defence missiles that can be produced at scale.
But kinetic weapons are not the whole story. SensusQ’s product is a decision-support system that draws on several disparate sources of data to give a concise intelligence summary. This system and others like it, such as those made by US company Palantir, are an example of how AI tools are coming to redefine modern warfare. But Kannike believes SensusQ can outcompete Palantir with the advantage that it does not put European military data in a US tech company’s hands.
“The key differentiator is our European heritage,” says Kannike. “Our system is 100% owned by our clients. The data that they’re collecting, we never have access [to].”
The role of larger companies
Europe and the US’s largest defence companies have been paying close attention to innovation happening on the ground in Ukraine for some time, and now the same is starting to happen for the Estonian industry, especially as more of its technology finds it way to the battlefield for testing.
The Latitude59 event in May showcased startup technology to investors visiting the country, and in September the country will hold a similar event.
While many of Estonia’s defence startups are still very small, Kannike says strategic investments in the sector by the big industry primes could “benefit both sides”.
“It would open up [the Estonian] market for some of these [large defence] companies,” he says. “[It] would give the required funds to actually kickstart [startup] defence companies to the level of technology readiness needed.”
Now that the sector has three years’ worth of momentum behind it, that may well be the next step.
