With AUKUS and the defence strategic review, we now have some clarity on Australia’s defence capability needs, but the ‘how’ of delivery is to be determined. Defence industry is a key enabler, but Australia’s defence industry policies have met with only partial success. Individual measures, like the acquisition of a controlling stake in CEA Technologies, indicate a willingness to act with resolve, but the scale of our strategic challenge demands fundamentally new thinking on defence industry policy and on the policymaking capability itself.

The specific challenges for the Department of Defence and defence industry are well known: innovation, industry support, procurement and value for money.

In my previous article ^[1], I outlined the policy path that’s been well trodden by countries that have attained rapid technical and industrial development. I highlighted the centrality of exporting firms, and our opportunity to harness the might of Australia’s financial services sector. Here, I propose a means of doing this that specifically addresses some of the challenges.

In the absence of a new federal department ^[2], Defence should create its own investment arm with the core function of investing in and attracting private investment into defence industry, focusing on exporting firms, and with a role in policy formation.

The benefits of greater private investor participation in the defence sector were succinctly set out ^[3] in the Australian Financial Review by John Kunkel and Hayley Channer. Here I add further arguments in favour of this and note the centrality of an investor’s mindset to the rapid development of industry capability.

Such investors include superannuation funds and family offices that invest directly in assets, private equity funds and venture capital funds. They control around $4 trillion in assets, a good chunk of which is directly invested in infrastructure and firms. Investors can bring much-needed expansion capital to the defence sector, and expertise in growing companies or ‘sweating’ infrastructure assets to maximise return on investment. This is an invaluable base of knowledge for Defence.

But the most profound contribution of private investors is cultural. Defence is culturally introverted—a product of its approach to information security. The economic historian Joe Studwell notes ^[4] that economically introverted states tend to have economies that are ‘technology-less’ and ‘dependent on multinationals, eking out a living as contractors’. That description can apply to much of Australia’s defence industry, which culturally reflects Defence.

Rapid development requires more extroversion, and financial investors are the ultimate economic extroverts. They’re wide open to new associations and opportunities, so long as their financial-return hurdles are met. An alliance between Defence introverts and financial investor extroverts could be a powerful driver to shape and grow industry.

Given the cultural differences, making common cause won’t be easy. In Silicon Valley, the Pentagon has reined in investors’ extroverted interactions with China. Defence-oriented investors have their criticisms of the Defense Innovation Unit and of difficult Pentagon procurement processes, but there are a critical mass of defence-oriented investors and established pathways of engagement.

In Australia, there’s limited private investor activity. CPE Capital, a private equity firm, is aggregating parts of the F-35 supply chain. Venture capital firms make isolated investments in dual-use companies and technologies, such as Main Sequence (In-Q-Tel is active too, though with a narrow focus). But, given the scale of private capital in Australia and the size of the defence spend, activity levels in Australia are underweight.

The investment arm of Defence (let’s call it ‘the Defence Investor’) will invest in industry and work with Defence to shape investment cases capable of attracting co-investment from private financial investors. It will do that through direct investment in industry and by acting as a fund of funds, providing capital to investors willing to work towards strategic objectives.

The Defence Investor will address the key challenges thus:

• Innovation: Direct investments alongside trusted co-investors across the capital stack in early stage and growth-stage technology companies and invest as a limited partner in venture capital funds, to co-create a pathway for the commercialisation of technology into exportable dual-use products. Use extroverted private investors as a fulcrum to translate technology into capability.
• Industry support: Direct investments into and alongside private equity funds and family offices to grow and consolidate the Australian manufacturing sector, creating the ‘missing middle’ integrators between small and medium-sized enterprises and the primes. Provide cornerstone equity in initial public offerings when funds seek to exit their investments to incentivise the listing of middle-market defence businesses on the ASX. It can also hold the equity of sensitive entities marked for government ownership (such as CEA Technologies), providing them with a quasi-commercial home.
• Procurement: Create a pipeline strategy along with the Advanced Strategic Capabilities Accelerator (ASCA) to mould industry capability to Defence’s needs by investing in a limited number of providers targeted for sole-source procurements.
• Value for money: Structure offtake and capacity models to incentivise direct investment in the defence estate from superannuation funds and other Australian investors to smooth infrastructure outlays (subject to accounting treatment) and sweat the estate.

The Defence Investor can also offer:

• Policy leadership: Provide in-house advice to Defence to craft industry policies that balance vigorous economic activity against accountability for strategic objectives (balancing the extroverted with the introverted).
• Business and investment pathways: Arrange placements of public servants and Australian Defence Force personnel in venture capital and private equity firms (like the Pentagon’s Defense Ventures 12-month tours) to build capacity within Defence, build trust between financiers and Defence, and strengthen the pipeline of ex-ADF innovators.

The direct investment path is well established in other parts of government (for example, Main Sequence, Export Finance Australia and the Clean Energy Finance Corporation) and in defence policy elsewhere (such as AFWERX in the US, and in Europe NATO’s Defence Innovation Fund and France’s Definvest). All these state-backed defence investors have four features in common: independent investment decision-making powers, a clear investment thesis and strategy, clear policy objectives to inform the investment thesis and strategy, and expert personnel.

The Defence Investor will be separate from but closely allied with ASCA. While independent, it will maintain deep links with the services, and that connectivity will inform its investment decisions. Its relationship to the National Reconstruction Fund will need to be determined.

Its strategic objective will be to work with ASCA and trusted co-investors to create an Australian dual-use innovation and industry pipeline, fuelled by multiple stages of deployed capital, from seed and early-stage funding through to buy-outs and in some cases initial public offerings. It will also structure infrastructure financing transactions. Target investees will be current and prospective suppliers to the ADF but will be expected to have an export-centred business model to facilitate efficiency and scale.

The Defence Investor will be built and staffed by professional financiers. Only by hosting a selection of investors, corporate development experts and professional infrastructure investors will Defence gain something genuinely additive to its culture.

The Defence Investor will succeed only in a broader industry policy environment that’s open to widescale public investment, including an acceptance that some investments will fail, and indeed should be allowed to do so.

Defence’s bold objectives require bold solutions.