For decades, the vast market of selling technology to the British government was seen by many investors as a quagmire, plagued by slow, opaque processes and formidable barriers to entry. Today, that perception is shifting dramatically, with defence and artificial intelligence emerging as powerful forces making the UK’s govtech sector a newly attractive proposition for serious capital.
The Allure of a Once-Impenetrable Market
The core challenges of govtech—companies selling products and services to government—are well documented. Startups face notoriously lengthy tender processes, must navigate erratic and unpredictable procurement rhythms, and shoulder the burden of meeting stringent security compliances like Cyber Essentials+. A generalist procurement workforce within government and a lack of centralised data on spending further complicate the landscape. Despite the UK public sector spending at least £14 billion annually on digital and technology, cost overruns and skills gaps have been persistent issues, with some digital initiatives seeing costs balloon by 26% above forecast.
Yet, a significant crack has appeared in the wall. In 2025, a record 35% of UK government tech contracts were awarded to small and medium-sized enterprises, signalling a conscious move towards a more dynamic marketplace. This opening is being aggressively exploited by a new wave of companies, not despite the sector’s traditional hurdles, but because two specific areas—defence and AI—are actively overcoming them.
How Defence and AI Are Reshaping the Investment Case
The transformation is most evident in how defence priorities and artificial intelligence are rewriting the rules of engagement. Geopolitical tensions and increased government spending are creating a high-demand, well-funded environment for specific technologies. The UK government has committed to raising defence spending to 2.5% of GDP by 2027, with an aspiration for 3.5% by 2035. This financial commitment provides a clear, long-term demand signal that directly counters the historical problem of unpredictable procurement.
Concurrently, the government is launching targeted initiatives to streamline access. A £28 million startup fund has been established to help small British companies enter the defence sector, while an Office of Small Business Growth within the Ministry of Defence aims to guide SMEs through procurement. A broader £5 billion tech investment package is designed to boost spending on novel technologies. These measures directly address the traditional sales cycle and market access barriers that deterred investors.
Strategically, the 2025 Strategic Defence Review places AI at the core of a future “Integrated Force,” aiming for a digital “targeting web” by 2027 to connect sensors and weapons systems. This vision is fuelling venture capital investment into AI-powered defence solutions. Companies like Helsing, a German AI drone maker with UK contracts, and Anduril, developing AI-powered autonomous systems, have secured significant funding and government work. The MoD’s Asgard programme, involving over two dozen firms including Anduril, Helsing, QinetiQ, and Leonardo, aims to use AI and novel networks to deliver a “tenfold increase in lethality.”
The investment appeal is broadened by the “dual-use” nature of many technologies, which have both military and civilian applications. Furthermore, strategic partnerships, such as the one with US firm Palantir—which plans to make the UK its European defence HQ and invest up to £1.5 billion—are intended to catalyse the wider ecosystem. The government’s wider AI Opportunities Action Plan, which includes creating AI Growth Zones and a National Data Library, further bolsters the infrastructure for these companies.
This activity has catalysed a venture capital surge into defence tech. Recent funding rounds highlight the trend: PhysicsX, a UK manufacturing platform working with defence, raised $155 million; Cambridge Aerospace, a missile interception startup, reportedly secured a $100 million round; and Portuguese-UK drone firm Tekever became a unicorn after winning a Royal Air Force contract. Other key players include UK intelligence firm Adarga, which secured a £12 million MoD grant, and Faculty AI, a consultancy developing AI for military drones and involved in the Asgard programme.
Nevertheless, scepticism remains. Some investors still perceive defence as challenging due to long development cycles and a perceived government slowness in technology adoption. Concerns have also been raised about “phantom investments,” questioning whether all announced capital and infrastructure will materialise. The sector’s growth, while promising, continues to navigate the inherent complexities of public procurement, where a unified, cross-departmental govtech strategy is still lacking and programmes often operate in silos. The journey from investible to consistently profitable in UK govtech is being paved, but the route is being decisively charted by defence and artificial intelligence.
