Venture Capital's Defense Boom Faces Return Reality Check

In Brief:

Defense technology venture capital investment has surged from $1 billion in 2020 to $7 billion in 2024, creating what appears to be the industry's next major theme after AI's recent dominance. However, veteran investor Alex van Someren warns that venture capital remains "one of the hardest ways to make money" and cautions against the herd mentality that periodically drives stampedes toward fashionable sectors. Speaking on the Fund Shack podcast, the co-founder of cryptography firm nCipher and former partner at Amadeus Capital Partners brings four decades of investment experience, having witnessed multiple technology cycles while serving as the UK's Chief Scientific Adviser for National Security from 2021 to 2024. Now working with Washington-based Paladin Capital Group, a firm that has specialized in defense-linked venture capital for 25 years, van Someren offers a sobering perspective on an industry where "the number of venture capital firms that are actually really financially incredibly successful is very very small."

Big Picture Drivers:

• Herd Mentality: Venture capital exhibits "stampede" behavior, moving from AI obsession to defense technology as the next fashionable investment theme

• Government Spending Surge: NATO countries increasing defense commitments, with some targeting 5% of GDP, creating massive new markets for private investors

• Risk-Return Mismatch: Fundamental tension between venture capital's need to lose "at least half" investments and limited partner expectations for returns

• Dual-Use Opportunity: Almost every emerging technology now serves both civilian and military markets, expanding addressable markets for investors

Key Themes:

• Performance Reality: Only a tiny fraction of venture capital firms deliver exceptional financial returns despite increased money and participants entering the market

• Portfolio Construction: Successful venture investing requires deliberately accepting high failure rates, with losing half of investments considered minimum risk-taking

• Market Timing: Investment themes follow predictable cycles, with defense technology emerging as the dominant focus after AI's recent peak

• Due Diligence Evolution: ESG restrictions being relaxed to allow investment in dual-use technologies as defense spending becomes socially acceptable again

Key Insights:

• Returns Concentration: European venture capital firms have matched or exceeded US performance in recent years, but exceptional returns remain concentrated among a tiny number of brand-name firms that generate massive outliers.

• Investment Philosophy: Van Someren advocates that "if you aren't losing at least half your money, you're not taking enough risk," directly challenging conventional investment wisdom about capital preservation.

• Market Validation: The defense technology investment surge reflects genuine demand rather than mere hype, driven by actual conflicts and government spending commitments rather than speculative betting.

• Fund Performance: Running a venture capital firm carries nearly the same risk as the startups they invest in, with most limited partners likely to lose money in VC funds just as those funds lose money in portfolio companies.

• Luck Factor: Van Someren emphasizes that both entrepreneurs and venture capitalists underestimate luck's role in successful outcomes, calling for more honesty about uncontrollable factors in investment success.

• Global Arbitrage: Smart venture capital requires global reach because "intelligent people with great ideas are everywhere," making geographic diversification essential for accessing the best opportunities.

Memorable Quotes:

• "If you aren't losing at least half your money, you're not taking enough risk" - van Someren, defining the fundamental paradox of venture capital investment

• "Venture capital is still one of the hardest ways to make money" - van Someren, tempering enthusiasm about the industry's growth and accessibility

• "The number of venture capital firms that are actually really financially incredibly successful is very very small" - van Someren, explaining the concentration of returns in venture capital

• "It's almost as risky running a venture capital firm as it is the investments that it makes" - van Someren, comparing fund-level and portfolio-level risk

• "Finally, I would just like to pay tribute to luck... some of these successes are actually just about luck" - van Someren, emphasizing the role of uncontrollable factors in investment outcomes

The Wrap:

Van Someren's perspective reveals venture capital's current defense technology surge as both a legitimate response to geopolitical realities and another example of the industry's tendency toward thematic investing. His emphasis on accepting massive failure rates and acknowledging luck's role provides a counterbalance to the industry's typical growth narratives. With defense spending creating genuine new markets while ESG restrictions relax around dual-use technologies, investors face the challenge of distinguishing between sustainable opportunities and temporary themes. The conversation underscores that despite increased capital and participants, exceptional venture capital returns remain concentrated among a small number of firms, making fund selection as crucial as ever for limited partners seeking exposure to innovation-driven growth.