The “Zeitenwende”, combined with recent geopolitical developments, continues to reshape Germany’s defense industry. Budget stability (including the German €100 billion special defense fund and a path to NATO’s 2 percent target), EU industrial policy in the defense sector (EDF, EDIRPA/ASAP and the European Defence Industrial Strategy), as well as growing comfort among European LPs have widened the investable set – especially in dual‑use deep tech (sensors, EW, autonomy, space, secure comms, cyber, munitions and sustainment). Deal flow features growth rounds, carve‑outs and capacity‑driven consolidation (notably in ammunition and critical components), showcasing increasing interest from (domestic and foreign) investors in the German defense sector and the need for high-profile startups to secure funding.
Also, Defense Innovation Accelerator for the North Atlantic (DIANA) – a NATO accelerator staffed by NATO employees that runs a competitive global accelerator program that supports founders through education and access to scientific testbeds, and issues non-dilutive grants – and NATO Innovation Fund (NIF) – a standalone venture capital fund (founded by NATO and funded by capital of the 24 sovereign NATO-alliance member countries) that supports both startups and funds in the 24 participating Allied nations through leading investment rounds, serving on boards, and providing equity funding – are helping catalyze dual‑use and defense‑tech deal flow, including in Germany, and backing founders and funds to address challenges to defense, security and resilience.
For investors, startups and founders alike, it is crucial to understand and navigate the applicable legal and regulatory frameworks that govern defense-sector deal-making.
Key Regulatory Frameworks
1. Foreign Direct Investment Control (FDI) under the Foreign Trade and Payments Act (AWG) and the Foreign Trade and Payments Ordinance (AWV); EU Developments
a) Scope and triggers: Defense and sensitive dual‑use assets are subject to mandatory, suspensory review – even for EU/EFTA buyers. The jurisdictional test captures acquisitions of 10 percent or more of the voting rights (including subsequent stake increases) as well as governance rights (board seats, vetoes, extensive information rights); deals involving assets that resemble an operating unit can be in scope.
b) Process and remedies: Clearances by the Federal Ministry for Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie – BMWE) typically take several months; mitigation is common (security agreements, information ring‑fencing, German/EU‑national control for classified work, reporting/audit commitments). This may be reflected in deal documents by way of expansive FDI covenants, flexible long‑stop dates, reverse break fees/”hell or high water” efforts and strict interim data‑access firewalls.
c) EU developments: The EU’s FDI “2.0” reform (reform of the FDI-Screening-Regulation) and an EU‑level outbound investment tool are advancing through the legislative process. While final contours remain have yet to emerge, expect greater harmonization, more mandatory screenings for critical tech (including defense‑adjacent) and potential outbound notification/authorization requirements for certain third‑country investments. These will impact planning assumptions and signing/closing sequencing.
2. Export Controls and the War Weapons Regime
a) Dual‑use and military items: Classification/licensing is based on the EU Dual‑Use Regulation (2021/821) and the EU Common Military List; Germany’s AWG/AWV and the War Weapons Control Act (KWKG) add permit layers for “war weapons.” Their scope extends to tech transfers, brokering, technical assistance and re‑exports; U.S. ITAR/EAR overlays remain frequent in transatlantic portfolios.
b) Arms‑export law reform not completed: The legislative procedure initiated by the previous German government in relation to a new arms‑export control statute (Rüstungsexportkontrollgesetz) was not completed prior to the elections on 23 February 2025. Arms exports will therefore continue to be controlled on the basis of existing laws and the licensing requirements for war weapons enshrined in the German Basic Law (Grundgesetz). The new German government further indicated that it would continue processing licenses for defense equipment with highest priority to support Ukraine.
c) Russia, Belarus and circumvention: Successive EU legislative packages through 2024/2025, most recently on 23 October 2025, have tightened anti‑circumvention (including the “no Russia” re‑export clause for certain goods), widened designations and enhanced transit/supply‑chain controls. Diligence should stress end‑use and end‑user screening, third‑country routing and historic exposure.
3. Industrial Security and Classified Work
Companies handling classified information require facility and personnel clearances and need to adhere to German “defense and security-”rules; ownership changes may require advance approvals. Buyers that do not have suitable nationality or security posture often employ mitigation strategies (trustees, proxy structures, segregated entities, cleared managers). Expect constrained diligence, clean teams and staged integration for classified programs.
4. Public Procurement and Contracting
a) Framework: Defense procurement is primarily governed by the Procurement Regulation for the Defense and Security Sectors (Vergabeverordnung für die Bereiche Verteidigung und Sicherheit – VSVgV), which is implementing Directive 2009/81/EC, with frequent reliance on Article 346 of the Treaty on the Functioning of the European Union (TFEU). Germany’s ongoing procurement‑acceleration initiatives aim to compress timelines, but novation consent, change‑of‑control rights, security‑of‑supply undertakings and offset‑like obligations remain material diligence points.
b) EU industrial policy: The European Defence Industrial Strategy is operational; the proposed European Defence Industry Programme (EDIP) is progressing. Subsidy and co‑funding opportunities (EDF/ASAP/EDIRPA and anticipated EDIP tools) carry strings—eligibility, intellectual property, security‑of‑supply, audit and, in some cases, “EU value‑added” and “Buy‑European” Verify grant-transferability and post‑closing eligibility.
5. Competition, Foreign Subsidies and Information Exchange
a) Merger control: Consolidation in the defense sector can trigger merger reviews e.g. by the Federal Cartel Office (Bundeskartellamt – BkartA) or the European Commission. Robust clean‑team protocols are critical in the case of transactions involving competitors.
b) EU Foreign Subsidies Regulation (FSR): The FSR (effective since 12 July 2023) may constitute an additional regulatory hurdle in large defense concentrations and certain public procurements. Early scoping of non‑EU “financial contributions,” groupwide data collection and timeline impact is key.
6. Cyber, Data and AI Compliance
a) Network and Information Security Directive 2022/2555 (NIS2): The implementation of the EU NIS2 framework by the NIS-2 Implementation and Cyber Security Strengthening Act (NIS-2UmsuCG) initiated by the previous German government was designed to broaden the number of in‑scope entities and to impose stricter risk‑management, incident reporting and management‑liability requirements. The NIS-2UmsuCG was not implemented prior to the 23 February 2025 election but remains a priority in the legislative aspirations of the new government. Defense‑adjacent software, IT services providers and manufacturers are increasingly in scope and should focus on improving their information security and on implementing specific technical and organizational measures already on the basis of the NIS2 Directive, notwithstanding the fact that the NIS2 Directive has yet to be transposed into national law.
b) Cyber Resilience Act (CRA): Adopted at EU level with phased applicability from 2025 to 2027, the CRA provides for mandatory cybersecurity requirements for all products with digital elements sold on the EU market to protect consumers and businesses; it introduces security‑by‑design, vulnerability handling and CE‑marking obligations for connected products, including many dual‑use systems.
c) Artificial Intelligence Act (AI Act): The EU AI Act came into force on 1 August 2024 with phased compliance over a 36-month period starting in 2025. While military applications are not in scope, dual‑use and civil modules and internal tooling can be caught (e.g., high‑risk uses in critical infrastructure). Map models and systems early to avoid surprises.
7. VC/PE Market Observations
a) Capital mix: Specialist defense and dual‑use funds, European sovereign and development finance institution (DFI)-capital (e.g., KfW and EIF), corporate venture and the NATO Innovation Fund are active co‑ Valuations increasingly differentiate firms with export‑license robustness, sovereign‑grade QA and assured inputs (propellants, energetics).
b) Fund and governance hygiene: Policies of limited partners on “controversial weapons” and Sustainability-related Financial Disclosures Regulation (SFDR) “labelling” continue to constrain some strategies. Governance is often tailored to avoid inadvertent FDI triggers, for example, by limiting vetoes or sensitive-information rights preclearance. For hardware, milestone‑based tranches tied to certification, supplier qualification and permit issuance remain common.
Outlook
With sustained rearmament, EU industrial policy maturing and a deeper pool of defense‑literate capital, M&A in the German defense sector should remain active – especially in munitions capacity, air defense, EW/sensor stacks, secure communications, space and sustainment.
Gating items are predictable: FDI and industrial‑security clearances, merger control, export control comfort, procurement assignability, sanctions compliance and for large transactions, review under the EU Foreign Subsidies Regulation (FSR).
Given ongoing EU reforms (FDI 2.0, EDIP, potential outbound screening) and Germany’s arms‑export law project, investors should continue to build regulatory flexibility into term sheets, transaction documentation and timelines.
