Why aren't U.S. defense primes in Lviv?

Sign up for Counteroffensive Pro for free! Our mission: empowering the innovators who defend democracy, through defense industry journalism. Today we come from you live from Lviv, during IT Arena:

More than 5,000 entrepreneurs, innovators and journalists descended on Lviv over the last 24 hours to talk the future of Ukrainian tech, network and have fun…

… Although maybe too much fun, with one attendee projectile vomiting on a member of our team at the Mad Bar afterparty.

Miltech is the dominant theme at this year’s conference, highlighting how critical this sector will be for the future of the Ukrainian economy and post-war recovery.

“This year we can see defence tech and miltech are gaining popularity, as well as venture capital investments to this sector,” said Ivan Repeta, CEO of Empat, a software development company unrelated to defense.

Here’s a quick download of what we’re learning:

1. Out: Drone systems startups. In: Specialized component startups.

We are seeing far fewer companies building entire drone systems and more companies focused on specializing on the proprietary, innovative components that they are best at.

Eugene Zhebko, the co-founder of Teletactica, produces jamming-resistant modems and antennas: "When we talk about communication systems, or video links, it's a pretty specialized thing. So we need to find specific engineers with unique experience and our research development flow is completely different.

Oko Camera manufactures optics for drones: “When it came to buying a thermal imaging camera, it became clear that it was actually impossible to buy it in Ukraine at the beginning of the war, and… it was impossible to import it from abroad, because it was a dual-use product. So [Oko] developed [the] business model and started to produce cameras,” said Nazarii Nykolaichuk, a sales manager.

"Too many companies are building vertically-integrated OEM systems [the entire drone system] rather than developing their innovations into novel components/modules for flexibility and integration... into existing platforms," said Justin Zeefe, founding partner at Green Flag Ventures. "We are very impressed to see fewer new UAS and more modularized innovations this year."

There were several factors driving the proliferation of whole-drone-systems startups: decentralized acquisition by Ukrainian military units; urgent demand for complete systems due to the war; and entrepreneurs experimenting before settling into areas of specialization.

Specialization creates different challenges though: Mikhailo Shulhan is the CEO of Pawell, a battery company for sea drones and long-distance aerial drones. They're not raising capital, like many other startups at IT Arena. Instead, they're looking for partners that will collaborate on long-term contracts so they can plan their work further out into the future.

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2. Where are the American defense primes?

The largest U.S. defense contractors do not have a significant presence at this conference. Among participants, it feels like there is a sort of disinterest in so-called ‘cheap-tech’ — the good-enough solutions that Ukrainian innovators are making in large numbers and at extremely low cost.

For example, First Parsec is building a pulse jet engine, competing on price point/ease of construction. 20kg of thrust: only $500 per unit. He isn’t competing in complexity, or pure accuracy. He’s competing on cost and quantity.

"You can make it whenever you want with hand tools, and just [send it in waves] to overload the Russian air defense system, then launch specialized drones that you want to hit the target,” said founder Oleksii Vynokur.

The U.S. defense primes might scoff about selling these thin-margin products, but it would be a major strategic mistake not to be involved in the Ukraine defense innovation space — it’s not all about sales, it’s also about learning what you’ll need to develop countermeasures for in the future.

Not taking part could lead to mistakes about future threats: leading us to send unarmored humvees into a country where IEDs are an emerging threat… as one GWOT vet quipped to me recently, with the widespread proliferation of kamikaze drones, “now the IEDs are flying.”

3. Stampede of Nordic/Baltic/Polish investors hints at future trends

Led by Finnish investors Mikko-Pekka Hanski, Jussi Muurikainen and Erkki Panula, the nonprofit initiative The Bridge Of Trust brought some 100 investors from 12 countries keenly aware of the Russian threat. This is up from ~30 investors last year.

Although the U.S. has made up 83% of defense tech VC funding among NATO allies since 2018 (see dealroom report, pdf), it shows the eagerness of European investors in countries bordering Russia to get into the action.

“I want it to be an impact organiation that will spend dozens of years to help rebuild Ukraine, helping it become the number one European growth center,” Muurikainen said.

TBOT held a sold out event where startups pitched to a select group of attendees (the demand to get in was so high that the physically-imposing Erkki stood guard as both bouncer and host at the entrance).

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COMING SOON: Next issue, we’ll talk about how Ukrainian defense startups are trying to China-proof their supply chains — and more takeaways from our networking here in Lviv.

See something at IT Arena we should cover?

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