Analysis | Defensetech Is Not SaaS: Why Startups Fail Before the First Contract

Imagine the scene: a meeting with a senior procurement officer, a strong presentation, a warm handshake at the end. “We are very interested.” Three months later – silence.

Six months in – a brief update about an “internal process.” A year later – a request for a pilot worth $50,000. This is not failure. This is a typical first deal with a defense establishment client. Companies that don’t understand this pace in advance do not last long enough to see the real contract.

In the previous article, we discussed the importance of thinking big. The current focus is understanding how business thinking works in the defense market. It is vital to understand: 60% of deep-tech companies require more than 11 years until their exit. 

This is not necessarily bad news. Deep-tech funds show higher IRR than the broader market. Based on an analysis of more than 1,600 funds, deep-tech funds generate an average IRR of 16%, compared to only 10% for traditional tech funds. Patience, it turns out, pays off.

What significantly increases risk is the defense procurement cycle. Deals with the DoD can take 18 to 36 months from the first meeting to an initial contract. In NATO countries, sometimes even longer. A company that plans its runway according to SaaS timelines may run out of cash before the first contract is signed.

The first deal with a defense client

Who is the real buyer? In the defense market, there are at least three actors in every deal: the end user (soldier, pilot); the procurement authority; and the budget holder. A common mistake is falling in love with the end user, the one who likes the product. It is important to understand that different cycles exist depending on whether a company develops software, hardware, or platforms. A software company, for example, may move faster, but its moat is weaker.

Here's what a typical cycle looks like: The first feasibility stage requires about $300–400K and roughly 6–9 months. The second stage, for a prototype, requires about $2–2.5M and around 18–24 months. Early stages can be funded through various channels, such as SBIR. After completing the prototype, the process moves to production. In general, getting from feasibility to a production contract takes roughly 5–7 years. Today, in various countries, especially the US, there are mechanisms for faster procurement. Companies that are unfamiliar with these pathways, lose years.

According to a JP Morgan analysis, fewer than 16% of companies that received initial SBIR funding reached a production contract. This is the “valley of death” of defensetech. The period between prototype and production contract can create years of funding vacuum, where companies receive no government funding and are not yet generating sales.

Remember: a first contract with a defense entity is not business – it’s testing the waters. Early pilot contracts range between $50K and $300K and usually do not generate meaningful cash flow. Moreover, margins in defense tech differ significantly from software. Adaptation costs, insurance, integration, and maintenance consume a large share of revenue. And above all, money arrives late. Government payment cycles are typically 60–120 days, sometimes more. A company that plans its runway like a software company will find itself running out of cash exactly when the military customer starts showing real interest.

Defensetech funds: key considerations

As a defensetech focused fund, we see hundreds of companies a year. Here is what makes us move forward – and what makes us stop:

The team: First and foremost, we evaluate the team. Technical depth, willingness to dig into complexity, and ability to raise follow-on rounds. A red flag: founders who have never worked with a defense customer.

The moat: A real moat is built from four elements: IP, regulation and certifications (Milspec, ITAR), unique field data, and deep integration into customer systems. Three out of four already create a meaningful advantage.

The investors: Who is already in? Misalignment among investors can kill companies from within. A red flag: a generic fund that joined because “defense is hot,” without understanding procurement cycles.

Dual-use: a company that sells into both civilian and defense markets, with real revenue, proves the product works outside the controlled military environment.

Deep defense knowledge: the ability to navigate procurement cycles, regulatory requirements, export controls, and maintenance demands, builds a moat that money can’t buy.

What kills a deal for us? Inflated market sizing without real demand validation; a product that requires major process change on the customer side; pricing that works in SaaS but not in defense; and a founder who explains how much the military “needs” the product, but cannot identify who exactly will sign.

Common startup mistakes in defensetech

-Founders who think a proof of feasibility is a contract, are wrong. A successful proof of feasibility is not a procurement commitment. In the military, it is only the first step in a process that can take years.

-Founders who build only for the defense market put the company at risk. A company without civilian revenue comes into fundraising from a weaker position.

-Founders who choose investors without domain understanding create internal misalignment among shareholders and the board. An investor expecting SaaS-like ARR in a company waiting 24 months for its first contract creates unnecessary pressure.

-Companies that ignore or disrespect regulation (CMMC, FedRAMP, ITAR) stall. Companies that discover too late that their architecture does not comply will not be able to sell. Companies that do not invest in proximity to the Pentagon struggle commercially. Someone who knows the corridors of federal agencies is worth more than any investor pitch deck.

-Companies that miss the integration layer delay their sales. The military buys capability, not code. A product that does not integrate with existing systems will remain in the queue for years.

The Israeli opportunity

Israel sits in a position that is hard to replicate: deep operational experience, fast movement between military and industry, and natural access to the two fastest-growing markets – the US and Europe.

However, this advantage does not realize itself automatically. It only materializes for founders who enter the field with eyes wide open: those with strong teams, real moats, planned patience, and clear business progress – feasibility agreements with defense entities, early civilian revenue, or unique dual-use core technology.

If these four elements are in place, the market is waiting. If one is missing, it is better to build it first.

Esti Peshin is Partner at Aurelius Capital and former VP and Head of the Cyber Division at Israel Aerospace Industries (IAI). Alon Lifshitz is the Co-Founder and Managing Partner at the venture capital funds Hanco Ventures and Aurelius Capital.