On Reg

Mastering FDI, Export Controls and Security in Germany’s Defense Deals

• Dechert LLP • Episode 17

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Germany’s defense landscape is transforming. Between new budget commitments, a push to meet NATO’s 2% target and an assertive EU industrial strategy, deal flow in drones, sensors, cyber and munitions is on the rise. In this episode of On Reg, Angelo Lercara is joined by partners Carina Klaes-Staudt and Clemens York to highlight the latest tightening of Germany’s FDI regime – covering critical infrastructure, cyber, media and defense – alongside export-control rules and classified-information requirements. 

Show Notes

Hot Topic: Dealmaking in Germany's Defense Sector in 2025 – VC, PE and M&A – What’s New and What are the Main Regulatory Hurdles – Dechert OnPoint (November 2025)




Angelo Lercara:

Hello, everyone, and welcome to Dechert On Reg, the podcast where we explore the ever-changing landscape of financial regulations and the key issues that are shaping the future of asset management. I'm Angelo Lercara, a partner at Dechert and co-head of our regulatory product line. And in each episode, we'll be joined by expert colleagues and guests to explore the most pressing issues in financial regulation. In today's episode, we're taking a closer look at Germany's defense and dual use industry and why understanding the legal and regulatory frameworks around this sector is becoming absolutely essential for everyone involved in dealmaking. So, whether you're an industry insider or simply interested in the world of financial regulation, you don't want to miss this episode of Dechert On Reg. I'm excited to be joined by two of our experts today, my colleagues Carina Klaes-Staudt and Clemens York are here today to discuss with us. Hi Carina, hi Clemens, good to see you.

Carina Klaes-Staudt:

Hi Angelo. Good to see you.

Clemens York:

Hi Angelo, great to be with you today.

Angelo Lercara:

Let me start with a bit of context. Germany's“Zeitenwende,” combined with broader geopolitical shifts, is reshaping the country's defense landscape. We now have a budget stability, including the €100 billion Special Defense Fund, and a realistic path to meeting NATO's 2% spending target. Add to that a more assertive EU industrial policy and growing comfort among European LPs, and suddenly the investable universe is expanding. We're seeing real momentum in dual-use deep tech, things like sensors, electronic warfare, autonomy, space, secure communications, drones, cyber munitions and sustainment. Deal flow is building across growth, rounds, carve-outs and consolidation, especially in ammunition and critical components, but also drones, and domestic and foreign investors are leaning in, and German startups in this space absolutely need capital to scale. So with that backdrop, let's get into the practicalities. Carina, maybe let's start with the corporate law angle. For foreign funds and their managers looking at German defense or dual-use targets, what are the most common showstoppers or delay drivers you're seeing right now?

Carina Klaes-Staudt:

Thank you, Angelo. Well, there are a few potential showstoppers foreign funds should consider, properly analyze and seek legal advice on early in the transaction process in order to avoid a potential delay or even a stop or no-go of the transaction at a later stage. These include foreign direct investment control, or we say FDI, where a clearance when acquiring companies active in the defense and dual-use sector is mandatory for foreign, even EU or EFTA-based funds, but can also apply when acquiring a business unit in an asset deal. Also, you need to consider export control restrictions, particularly the EU dual-use regulation, the EU common military list, as well as Germany's War Weapons Control Act, which add permit layers for the export of war weapons with a scope extending to tech transfers, brokering, technical assistance and-re exports. And finally, German defense and security rules can be a showstopper when targets are handling classified information requiring facility and staff clearances, in which case ownership changes may need advanced approvals as well. And all of these approval and clearance requirements need to be factored into the overall transaction timeline.

Angelo Lercara:

Right. So, a lot of regulatory hurdles, maybe let's stay with that for a minute. Clemens, foreign investment control has clearly become a central topic in this sector. How has it developed over the last few years, and what impact is it having on dealmaking today. What are your views?

Clemens York:

Well, Angelo, foreign direct investment control has seen a significant surge globally in recent years, and Germany is certainly no exception to that. The German approach towards foreign investments has traditionally been very liberal, as you know, but the German legislator has significantly tightened the German FDI regime in recent years. There have been several rounds of legislative amendments, which means that now more and more non-EU or even non-EFTA investments in areas like critical infrastructure, cyber, tech, media, medical supplies and several more need to be notified to the German government. An important point for investors and potential sellers alike is that the German FDI regime imposes mandatory filing requirements in defense-related transactions, so any acquisition of defense-related or sensitive dual-use assets automatically requires a suspensory review, and that applies even if the buyer is based in the EU or in EFTA. Purchases as low as 10% or more voting rights may be caught, and the same is true for stake increases above that threshold. So, that's particularly important to know for potential co-investors. In terms of substantive analysis, our experience is that the German government is currently very cautious with regards to the screening of transactions in the defense sector. Unconditional clearances in the defense sectors are very rare. Instead, you can expect to be negotiating mitigation measures, which often include security agreements, ring-fencing of sensitive data, requirements to ensure German or EU national control over classified work and various reporting and audit commitments. And finally, in terms of future developments to look out for, new investment screening legislation is expected to be adopted in Germany in the very short term, and that's likely to introduce even more scrutiny of foreign investment, in particular in critical infrastructure and defense. right

Angelo Lercara:

Right. Carina, when investors do push forward, is it actually possible to, you know, to structure around these regulatory barriers? Or how would that work? How could you navigate FDI thresholds, you know, export control, exposure and other sensitive asset issues?

Carina Klaes-Staudt:

There are a few common tools to manage or even avoid regulatory barriers which we see are being used in the market, which include, for example, carve-outs, meaning that certain assets or business units which are particularly subject to increased regulatory barriers are being carved out of the transaction perimeter prior to signing or closing. For example, a war weapons unit could be carved out to avoid falling under the respective act. Also, we see that trustee structures or ring-fencing structures are used to avoid exceeding certain holding thresholds, like the 10% voting rights meeting as Clemens just mentioned. Also, what we see is that funds are putting, particularly in shareholders agreements, certain voting rights restrictions which avoid the 10% voting rights trigger under the FDI control and with the same goal, other governance rights, such as board seats, specific veto rights, but also extensive information rights, which investors typically tend to ask for under other circumstances, are particularly avoided by foreign funds investing in German defense and dual-use targets.

Angelo Lercara:

Right, right. So there are tools available, you just need to know which one to use and to prepare on time before looking into specific transactions. I assume, Clemens, merger control plays a role, maybe a big one. What about merger control in the defense sector? What are the hot topics, actually? Or are there any hot topics currently?

Clemens York:

Well, you know, Angelo, in merger control, it's really about striking a balance between the imperative of maintaining robust and competitive markets, on the one hand, with the strategic needs of national defense. On the other, the goal, of course, is always to ensure that mergers don't compromise the ability to deliver advanced, cost-effective solutions to defense challenges. But how do you get there? When competition authorities review transactions, they're typically focused on assessing if the deal could negatively impact competition in a relevant market by, for example, leading to higher prices diminished quality or service, or by stifling innovation, which has been a big topic in the competition circuit recently. Reviewing mergers in the defense sector presents some very unique challenges due to the industry's very distinct characteristics. The market is heavily regulated, it often features a single customer, typically the National Defense Department, and procurement processes are quite different from those in many other industries. Also, the defense market involves complex and heterogeneous products. So, the nature of products and services, from weapon systems to surveillance technology, is really crucial for the context in which these mergers are assessed, and that means that a granular approach is typically required to define relevant markets. If you consider that products designed for different applications rarely compete directly, that means that the specific missions the weapon systems are designed for often determine the parameters of the relevant market. And on top of that, in a sector like the defense industry, where technological advancements can rapidly change the competitive landscape, historical market shares might not provide a complete and accurate picture of competitive conditions, unlike what you see in many other industries. So, it's often crucial to take a forward-looking approach involving potential technological shifts, the intricacies of procurement processes, and also barriers to market entry, which we see a lot in the defense sector. Another important feature is that merger control rules provide for a security exemption that allows for a merger that might otherwise raise competition concerns to be justified on grounds of public security. That does provide for some flexibility in merger review processes in some very exceptional cases, but the primary analysis still centers on ensuring that the merger does not detrimentally affect market competition and innovation.

Angelo Lercara:

Right, interesting. Carina, we're also hearing a lot about the need for more flexibility in deal documents. What does regulatory flexibility actually look like in term sheets today? Which clauses are becoming standard or more relevant?

Carina Klaes-Staudt:

Generally, I would say the standard clauses we used to see previously in term sheets are still important for defense and dual-use sector term sheets, but specifically adapted to the regulatory needs of this industry. So for example, when it comes to due diligence, what you see, particularly when public procurement comes into place, we see a lot of specific due diligence requirements tying around change of control, security of supply, undertakings and offsite-like obligations which remain material, diligence points, which you would already factor into the term sheet. But also, specifically, when it comes to long stop dates, you need to look at the requirements of FDI control, what Clemens just mentioned in terms of merger control. All these timelines need to be factored into the long stop date agreed for these specific transactions. We see reverse break fees if the other party does not cooperate sufficiently. We also see mitigation undertakings in the term sheets and specific sequencing between signing and closing, which ties into the long stop date I already mentioned before. What we also see are specific licensing conditions and governance limits I mentioned already before in terms of governance limits that veto rights are often already limited in the term sheet, but also board seats are excluded, specifically.

Angelo Lercara:

If you were advising a first-time global fund entering this space, what are the, let's say, the three priorities you would highlight, and on the flip side, maybe for German targets, what mistakes most often derail investor interest? What would you say?

Carina Klaes-Staudt:

So, the three priorities and very, very high priority, would put into compliance with all of these regulations that is really vital for investors, also the structuring of their fund, that it complies with with all of these regulations, and the governance structures they put in place at the level of the target entities. These are, so, structuring, governance, compliance are the three most important priorities I would advise foreign funds on to comply.

Angelo Lercara:

And sorry, Carina, actually it's a good point that the fund managers should look into their fund documents whether there are any restrictions. And probably, you know, the more regulated the investors in the fund are, the more likely it is that you would have restrictions, either in the fund documents, directly or maybe in a side letter. Yeah, these are, these are good points.

Carina Klaes-Staudt:

Yeah, exactly. And from the target's perspective, when talking about common pitfalls, it's, of course, observing the overall ownership structure in the target, the export and FDI readiness at the target level, but also documentation gaps or weak control mechanisms at the level of the target, that is something which the target itself, and also the investor, when doing its diligence of the target carefully needs to consider.

Angelo Lercara:

Yeah, and I guess the targets need to have a very clear understanding on which of the assets would actually be dual use. So, I assume they would have to do a proper due diligence to understand exactly if they would fall under any of these restrictions, or any of the assets would fall under these restrictions. I guess, so, that's on the German target side that they have to do their homework as well.

Carina Klaes-Staudt:

Yes, exactly. And that's particularly true with respect to software companies, which are often not fully aware that they might fall into the dual-use regulations.

Angelo Lercara:

Right, OK, thanks. Clemens, before we wrap up, what's your main piece of advice for our audience as they look at defense and dual-use opportunities in Germany?

Clemens York:

Well, Angelo, I would say that the single most important regulatory message for investors in defense and dual use is treat national security screening, merger control, FSR and export controls as core deal design issues, not just a closing checklist item, and build them into strategy valuation and governments from day one. Any investment in defense and dual use should assume that regulatory aspects are going to heavily shape what can be done with the asset post-closing that affects not only operations, but also which co-investors, JV partners and exit routes are actually realistically available to an investor. Authorities are increasingly expecting a very coherent economic and security story, so how the investor expects to strengthen capabilities, ensure resilient supply and prevent leakage of sensitive information. So, investors that articulate this narrative in a credible way and provide evidence of compliance culture and transparency typically will have far better chances of navigating reviews faster and with more manageable conditions.

Angelo Lercara:

Right. Carina, Clemens, a big thank you for joining us and sharing your insights with us. We really appreciated your expertise, and it's been great having you in this conversation. Thanks a lot.

Carina Klaes-Staudt:

Thank you, Angelo, it was a pleasure.

Clemens York:

Thanks a lot, Angelo.

Angelo Lercara:

As we wrap up today's episode, I'd like to extend my thanks to our incredible production team. It is their dedication and hard work behind the scenes that make this podcast possible. So, here's to our talented producers, sound engineers and everyone else involved in bringing this show to life. To our listeners, thank you for tuning in to our financial regulatory podcast. We hope that you found today's episode informative and engaging. If you enjoyed the show, please consider subscribing, rating and reviewing us on your favorite podcast platform. See you next time.