Corporate transactions in the defense sector: What matters in M&A processes

Ongoing security tensions in Eastern Europe and increasing global geopolitical challenges have led to a fundamental change in European and German security and defense policy. This has enabled the arms and defense industry in Germany to reposition itself in recent years and highlight its strategic importance for national and European security.

This benefits not only the domestic arms industry, but also the European arms industry. In Germany alone, companies in the defense sector have recorded a 36 per cent increase in sales since 2021 to currently EUR 31 billion, and the trend is rising sharply. The resulting sales expectations make the acquisition of companies in this sector particularly interesting at present, as demonstrated not least by Rheinmetall's takeover of Naval Vessels Lürssen (NVL).

M&A transactions in the defense sector do not only serve economic goals. Rather, they are also a strategic lever for strengthening the industrial resilience of one's own country, securing access to critical technologies and addressing national security requirements. However, acquisition (M&A) processes in the defense sector differ significantly from transactions in other industries. 

This article will highlight some of these special features:

1.    The peculiarities of German regulation

First of all, the special regulation of the German arms market must be taken into account. As a result of the Second World War, the manufacture, transport and marketing of weapons of war are subject to special restrictions and licensing requirements under Article 26(2) sentence 1 of the German Basic Law (Grundgesetz – GG) and the War Weapons Control Act (Kriegswaffenkontrollgesetz – KrWaffKontrG). The ban on the stockpiling of weapons of war poses a particular challenge for investors in Germany. This is compounded by complex and lengthy approval procedures. Foreign investors are also subject to a reporting obligation to the Federal Ministry for Economic Affairs and Climate Protection (Bundesministerium für Wirtschaft und Klimaschutz – BMWK) in accordance with Sections 60 ff. of the Foreign Trade and Payments Ordinance (Außenwirtschaftsverornung – AWV). This includes any acquisition of 10 per cent or more of the voting rights in an armaments company. However, not only such share deals, but also the acquisition of certain assets of the company (asset deal) and foreign transactions involving a German subsidiary are subject to the reporting requirement. Furthermore, even direct and indirect investments from other EU countries and those in the defense supply sector are subject to reporting requirements. Acquisition agreements must therefore take into account the possibility of a national security review and the risk that the transaction may be prohibited or subject to strict conditions.

At the same time, the export of goods and technologies that are designed or could be suitable for military purposes (so-called dual-use items) is regulated by EU law (Dual-Use Regulation, Regulation (EU) 2021/821). Depending on the circumstances, European economic sanctions, the US International Traffic in Arms Regulations (ITAR) or US extraterritorial sanctions may also apply. 

All of these regulations must be taken into account in the due diligence process prior to the acquisition. Investors should be aware of the restrictions that these laws and programmes may impose on them both during the acquisition process and during the integration of the target company after closing.

2.    The issue of sensitive data and intellectual property

German companies in the defense sector mostly work with classified information or participate in confidential government contracts. This poses specific compliance risks for the defense sector, limits the scope of due diligence procedures and presents particular challenges for the integration of the acquired company.

Intellectual property is often a crucial asset in the defense sector and requires thorough examination. Company purchase agreements in this area therefore often contain extensive industry-specific provisions on the transfer or licensing of intellectual property rights, which are often aimed at ensuring the maintenance and support of armed forces equipment even after the end of the contract. When cooperating with public institutions or foreign partners, the issue of intellectual property can become even more complex, as demonstrated by the impending termination of cooperation between Germany and France on the Future Combat Air System (FCAS) project.

3.    Complexity of supply chains in the defense sector

The domestic defense industry is firmly integrated into European and, as the problem of rare earths shows, global supply chains. Defense companies often act as suppliers, integrators or prime contractors and usually interact with governments, customers, suppliers and partners at home and abroad.

This interconnectedness creates strategic opportunities, but also harbours considerable regulatory risks, as German companies often have to comply with foreign standards such as the US International Traffic in Arms Regulation (ITAR), and a change of control can trigger requirements for third-party approvals or regulatory notifications in multiple jurisdictions.

Therefore, due diligence in defense sector acquisition negotiations must include a careful review of liability allocation clauses, industrial and technological advantage obligations, and the status of ongoing projects – often the core of the target company's success. Obtaining the necessary third-party approvals should be integrated into the closing conditions. Finally, post-acquisition synergies must be assessed with regard to cross-border integration, which can be a powerful growth tool but also involves significant contractual and regulatory complexity.

4. M&A financing in a rapidly changing sector

For a long time, many public, institutional and private funds avoided the defense sector because, in addition to historical resentment, there was a perception in Germany that the defense sector was incompatible with ESG (environmental, social, governance) principles due to reputational risks associated with weapons, conflicts and corruption. This perception has now changed for the most part, as defense is increasingly seen as a strategic industry that is crucial to national stability and sovereignty. Lenders and investors are slowly responding to this by revising their exclusion criteria, distinguishing between defense-related and purely military activities, developing an industry-specific ESG framework, focusing on transparency, governance, anti-corruption compliance and human rights, and introducing tailor-made due diligence mechanisms. As a result, the defense sector continues to be viewed as sensitive, but is increasingly considered ‘investable’ for companies with strong corporate governance, strict regulatory compliance and proactive ESG risk management. This transition process must be incorporated into the closing process, including financing terms, representations and warranties, and investor expectations.

5.    Incorporating the impact of geopolitical tensions

Beyond national security reviews, international tensions – whether armed conflicts, trade disputes or tariff wars – can have a direct impact on transactions in the defense sector. Such developments can influence investment decisions, strategic alliances and regulatory approvals, while also disrupting supply chains, increasing costs and creating uncertainty. Arms purchase agreements should therefore always explicitly address the potential impact of such disruptions on the planned transaction and its execution.

6.    Integrating ESG, ethics and compliance considerations

The integration of ESG criteria is now crucial for attracting capital and minimising reputational risks. Historically, the defense sector in all countries has been particularly vulnerable to corruption because governments are regularly the end users and the procurement process often involves several intermediaries. This is one of the reasons why anti-corruption laws in Germany and other jurisdictions provide for severe criminal and civil penalties for companies and individuals who offer or accept bribes. These risks must therefore be carefully assessed during the due diligence process and taken into account in the M&A agreement – in particular through representations, warranties and indemnification provisions to ensure robust compliance and ethical safeguards.

7.    Consideration of defense sector-specific aspects in transaction documents and negotiations

Finally, the special characteristics of the defense sector influence not only the company valuation and due diligence review, but also the drafting of the transaction documents and the course of the contract negotiations. Acquisition agreements therefore typically include:

• The determination of regulatory approvals and compliance with applicable regulatory law, the granting of necessary licences or authorisations, and the consent of the contracting parties to transfers or changes of control;
• Extended representations and warranties covering regulatory compliance, the handling of sensitive data, intellectual property rights and freedom from corruption; and
• comprehensive indemnification provisions tailored specifically to risks identified during due diligence, which includes compliance with laws and regulations.

As with any M&A transaction, those in the defense sector must be carefully planned and executed. Industry-specific considerations must never be overlooked. In a context characterised by rising public investment, increasing geopolitical tensions and pressure to innovate and increase productivity, corporate transactions are and will remain a powerful driver of growth – provided that the specific characteristics of the industry are sufficiently taken into account.

Our lawyers specialising in acquisitions, sales, conversions and regulatory compliance, particularly in the tech sector, work closely together to guide clients through these challenges and support their strategic growth in this highly sensitive sector. Dr Thomas Hausbeck, LL.M., and the defense team at SKW Schwarz are happy to assist your company in effectively pursuing its sustainability goals.