Due Diligence In Canadian Defence And Dual-use Investment

This insight is a companion to Venture capital opportunities in Canada’s defence sector which addresses the market landscape, government investment vehicles and the strategic opportunity for venture capital in Canadian defence and dual-use technology. Here, we address practical due diligence considerations that arise when evaluating opportunities in this sector.

Due diligence considerations differ depending on the nature of the investment decision. A direct investor, for example, a fund making an equity investment into a defence or dual-use company, must evaluate the company’s regulatory profile, technology and commercial pathway. A limited partner (LP) investing into a fund with a defence mandate will evaluate the fund manager’s strategy, expertise and structural positioning, with company-level considerations one layer down. The frameworks discussed below apply at both levels but require different analysis at each. Engaging experienced counsel early is strongly advisable regardless of the investment decision.

Alignment with government priorities

The starting point for any investment in this sector, whether at the company or fund level, is alignment with the Defence Industrial Strategy (DIS) and the ten sovereign capabilities it identifies as federal priorities. The DIS is the framework through which the federal government will direct procurement, target Business Development Bank of Canada (BDC) financing, and assess eligibility for programs including the Regional Defence Investment Initiative and the BDC Defence Platform.

For a direct investor, the threshold question is whether a specific company has a credible pathway to a government or allied customer, not simply a plausible dual-use application. BDC has stated it will assess small and medium sized enterprises (SME) opportunities based on whether there is clear demand from the Canadian Armed Forces (CAF) or allied nations; direct investors should apply the same test. The DIS’s Build–Partner–Buy procurement framework is also relevant at this level: in Build categories, new Canadian entrants have a structural procurement advantage, while Partner categories may require teaming arrangements with allied primes to access the market.

For a limited partner evaluating a fund manager, the equivalent question is whether the fund’s thesis is anchored in specific DIS sovereign capability categories where the manager has genuine domain expertise and demonstrable access to deal flow, rather than a broad claim on the defence opportunity. A fund mandate that covers the full DIS landscape without specialist depth in any particular category is a diligence concern at the LP level.

Technology and niche specialization

The breadth of the dual-use category means almost any advanced technology company can construct a plausible defence narrative. The diligence disciplines to apply differ by investor type.

A direct investor should assess two things. First, whether the company’s products map onto one of the DIS’s ten sovereign capability categories with enough specificity to support a realistic procurement thesis. Second, whether the company has meaningful engagement with defence end users: field trials, IDEaS contracts, participation in NATO DIANA programs or relationships with CAF units or allied procurement offices. Validated military demand, not a credible civilian track record with a defence roadmap attached, is the relevant test.

A limited partner should assess whether the fund manager has genuine domain expertise in the categories it targets, access to proprietary deal flow in those categories, and the operational network to support portfolio companies through the defence procurement process. A manager without prior defence sector experience is asking its LPs to fund a learning curve that may not fit a standard fund timeline.

Dual-use pivot diligence

Companies newly exploring pivoting a civilian product toward defence customers are a distinct category from companies built from the ground up for defence. These transitions take longer and cost more than they typically appear in a pitch: adapting to defence specifications, navigating procurement timelines that differ sharply from commercial cycles and building the relationships required to win government contracts are each significant undertakings.

A direct investor evaluating a dual-use pivot should require realistic timelines, concrete milestones and evidence that the company’s operational and legal infrastructure is adequate to manage both markets simultaneously. Operating across civilian and defence markets creates a compliance environment that a single-domain company does not face: export controls, security requirements and procurement eligibility rules can apply differently depending on which market a given product or contract serves.

A limited partner should understand what proportion of a fund’s thesis depends on dual-use pivots versus purpose-built defence companies, and whether the manager has the expertise to evaluate and support pivots in the specific technology categories it targets. These are operationally intensive investments that benefit from hands-on fund management capacity that not all managers possess.

Procurement cycle risk and patient capital requirements

Defence procurement cycles can extend 5 to 8 years or longer from initial procurement solicitation to meaningful revenue, a dynamic that is poorly matched to traditional venture capital (VC) fund structures with ten-year lives and exit expectations in years 5 through 8.

A direct investor should conduct explicit diligence on a company’s revenue timeline and the extent to which near-term revenue can come from sources other than major procurement contracts, including allied customers, commercial applications and various government grants. A company entirely dependent on a single major procurement outcome for its first significant revenue is a different risk profile from one with a diversified early revenue base.

A limited partner should ask direct questions about how the fund manager models exit timelines for defence companies, what assumptions underlie those projections, and whether the fund’s life and return expectations are genuinely consistent with the sector’s dynamics. It may be that the presence of BDC as a co-investor or LP in a fund will come to signal alignment with government priorities and access to relationships that may accelerate procurement timelines: a practical benefit worth assessing as part of fund-level diligence.

Security clearance and regulatory considerations

Facility and personnel security clearances

Access to classified information, controlled goods and certain government contracts requires security clearances at both the company and individual levels. The facility security clearance (FSC) process, administered through Public Services and Procurement Canada, can take many months and requires the company to meet specific governance, ownership and personnel standards.

A direct investor should assess whether the target company has or is actively pursuing the appropriate clearance level for its intended market, and whether the company’s ownership structure, including any foreign shareholders or board members, creates obstacles to obtaining or maintaining clearance. The investor’s own ownership stake in the company may itself require disclosure and assessment. Cap table or governance restructuring may be a practical prerequisite to clearance eligibility, with legal and tax implications that require early planning.

A limited partner should understand how a fund manager evaluates clearance status as part of its investment process, and whether the fund’s own LP base creates any ownership-chain issues that could affect portfolio company clearance eligibility. A fund with LP capital from jurisdictions attracting security scrutiny may face constraints on the defence investments it can make that are not apparent from the fund’s mandate alone.

Controlled Goods Program

The Controlled Goods Program (CGP) regulates access to goods, technology and technical data related to weapons and military equipment. Companies that examine, possess or transfer controlled goods must be registered under the CGP and maintain a Designated Official responsible for day-to-day compliance with CGP requirements. CGP registration is a prerequisite for many defence contracts. A direct investor evaluating a company pitching a defence product line without CGP registration should ask why registration has not been obtained and what the plan and timeline for doing so is. A limited partner should understand whether and how the fund manager incorporates CGP status into its screening process.

Export controls: US International Traffic in Arms Regulations (ITAR) and the Export and Import Permits Act (EIPA)

Canadian defence and dual-use companies face export control obligations under both Canadian and, frequently, US law. Canada’s EIPA and Export Control List (ECL) require permits for exports of military and sensitive goods to most destinations.

The US ITAR present a distinct and often complex challenge. ITAR may have extraterritorial effects and apply to Canadian and other foreign companies where they handle US-origin ITAR-controlled defence articles, technical data or defence services—particularly in connection with export, re-export or transfer activities. ITAR violations carry severe penalties including criminal liability.

A direct investor should review the company’s export control classification, any ITAR-controlled supply chain elements, existing technical assistance agreements or manufacturing licence agreements with US primes, and the quality of the company’s internal compliance program.

A limited partner should understand how the fund manager identifies and manages ITAR exposure across its portfolio, as an ITAR violation at one portfolio company can have consequences for the fund as a whole.

Canadian companies may benefit from the long-standing “Canadian exemption” under ITAR §126.5, which allows unclassified ITAR-controlled items to be transferred without a license to approved Canadian entities (subject to the conditions of the exemption). Canada’s participation in the EU SAFE instrument provides certain added benefits for dealings with EU countries but does not alter the ITAR exposure of companies with US-origin technology.

Investment Canada Act considerations

Bill C-34, the most significant overhaul of the Investment Canada Act (ICA) since the national security regime was introduced in 2009, received Royal Assent in March 2024, with key provisions in force since September 2024. The amendments expanded ministerial powers to extend reviews, impose interim conditions and accept binding undertakings to mitigate national security risk to avoid a national security challenge pre closing or a possible divestiture order post closing.

The remaining provisions of Bill C-34 are expected to come into force later. These require either regulatory amendments or an interpretation note before they can be implemented, including new ministerial power to review any foreign state-owned enterprise investment on net benefit grounds (except for SOEs from certain countries with which Canada has a trade agreement) and advancement of a national security review where the investor has been convicted of corruption. The most important amendment not yet implemented is the establishment of a mandatory pre-closing notification and national security clearance applicable to prescribed sensitive business activities. This new regime will apply to investments of any size by both controlling investors and non-controlling but influential investors. Note, however, that investors should engage early on with ICA counsel to identify the applicability of any exemptions to the ICA filing requirements (e.g., venture capital investments meeting certain criteria). Prescribed sectors may include critical infrastructure, critical minerals and their supply chains, and sensitive technology. Regulations prescribing these business activities are expected to be in force in late 2026 or very early 2027. Penalties for non-compliance may apply to the greater of CA$500,000 or an amount to be prescribed by regulation.

In addition, national security considerations now expressly include the broad concept of “economic security” as of March 2025 when the Canadian government’s national security guidance was updated. Under the economic security rubric, the government could consider whether an acquisition could shift jobs, research and development, head office functions, intellectual property ownership or key manufacturing operations abroad, potentially hollowing out domestic capability or resiliency. In applying this factor, the government has stated that it would consider, among other things, the size of the Canadian business targeted, its place in the innovation ecosystem and the impact on Canadian supply chains. The Canadian government might also consider whether a Canadian target was being acquired at a fire sale price due to broader economic pressures.

Two distinct ICA issues arise in this sector. The first is a company-level issue: companies pivoting toward dual-use or defence that carry legacy investors from jurisdictions attracting heightened scrutiny, including China and Russia, may find their existing shareholders a material obstacle to obtaining security clearances, accessing controlled goods, qualifying for defence procurement or attracting new institutional capital. Cap table restructuring may be a practical prerequisite, and that restructuring itself could be subject to national security review under the ICA. A direct investor conducting pre-investment diligence should assess the target’s existing cap table to identify such issues before making an investment.

The second is an investor-level issue: new investments in defence and dual-use companies will increasingly attract ICA scrutiny and investors from countries with which Canada has a free trade agreement are not immune from rejections. The 2023–2024 ICA Annual Report confirmed that a US investment was subjected to a national security review, resulting in its withdrawal. Both direct investors and fund managers making new investments in sensitive sectors should engage experienced counsel early on in the deal planning process and consider filing a notification at least 50 days prior to closing to Innovation Science and Economic Development Canada (ISED) officials where the sensitivity of the target’s business or the investor’s profile or both generate national security risk.

Intellectual property ownership and control

The DIS makes intellectual property (IP) sovereignty an explicit policy priority, directing procurement toward Canadian companies that own and control their core IP. Companies with unencumbered foundational IP, free of crown use rights from government grants, university licensing restrictions, or foreign-funded research obligations, are better positioned for defence contracts, institutional investment, and exit.

A direct investor should conduct explicit diligence on IP ownership chains, including whether any IP was developed under programs carrying commercialization restrictions or limiting the company’s ability to assign or sublicense to government customers. ITAR adds a further dimension: US government-funded research incorporated into a company’s products may carry government use rights even when embedded in a Canadian product. Companies that have received Defence Advanced Research Projects Agency (DARPA) or Department of Defence (DoD) funding or entered into cooperative research and development agreements with US national laboratories should document the IP rights implications.

A fund manager should have a clear and consistent position on IP structuring across the portfolio including whether to hold IP at the operating company or a holding company, how to manage IP developed jointly with government partners, and what contractual protections are appropriate in teaming arrangements with defence primes.

A limited partner should ask whether the fund manager has articulated this position and whether it has the legal expertise to implement it consistently across investments.

Cap table composition and fund structure

As alluded to above, cap table and LP composition are first-order considerations in Canadian defence investment in a way that does not arise in most other sectors, and the analysis differs materially depending on whether you are a direct investor, a fund manager, or a limited partner.

At the company level, foreign ownership from jurisdictions attracting closer ICA scrutiny can prevent a company from obtaining FSCs, accessing controlled goods under the CGP, or qualifying for contracts requiring all shareholders to meet security standards, regardless of whether the investment triggers formal ICA notification. A direct investor should assess the target’s existing cap table for these issues before investing, since the investor’s own entry will add to the ownership profile that government authorities will assess.

At the fund level, LP capital from foreign government-affiliated entities, sovereign wealth funds or institutional investors from scrutinized jurisdictions may constrain which defence and dual-use investments a fund can make and may create clearance issues that flow through to portfolio companies. A fund manager developing a defence mandate should take legal advice on LP composition and disclosure obligations before fundraising, not after closing. Special purpose vehicles or parallel fund structures can in some cases address these issues but are most effectively designed before the fund is raised rather than under deal-specific pressure. A limited partner should understand how the fund manager has thought through these constraints and what protections exist for LPs if a conflict arises between the fund’s LP base and a specific investment opportunity.

Exit considerations

Exit pathways for Canadian defence companies are less developed than in comparable sectors, and this should be factored into both fund-level return modelling and individual investment underwriting.

Strategic acquisition by a Canadian or allied prime is the most plausible exit pathway for most early-stage defence companies. The DIS creates some friction for foreign acquisition of companies in sovereign capability categories, but acquisitions by allied primes, US, UK, Australian, and European NATO members, are likely to remain viable subject to ICA review. The ICA’s national security review powers apply regardless of the size of transaction, and acquirers from non-allied jurisdictions face a higher bar. Public market exits through a traditional IPO, a CPC qualifying transaction or a TSX SPAC are viable for more mature companies and are addressed in a separate Dentons insight on go-public vehicles for defence-tech companies.

A direct investor should model exit scenarios with explicit assumptions about ICA review risk, foreign acquirer eligibility and the valuation differential between a domestic and a cross-border transaction. Companies with clean IP, clean cap tables and clearances in good standing are more attractive to the broadest range of acquirers.

A limited partner should ask how the fund manager has modelled exit optionality across its portfolio given the ICA constraints on foreign acquisition, and whether the fund’s projected returns are sensitive to the assumption that allied acquirers remain available.

Conclusion

Investing in Canadian defence and dual-use technology requires discipline that goes beyond standard venture diligence and the specific disciplines differ depending on whether the investment decision is a direct equity stake in a company or an LP commitment to a fund. Several of the considerations discussed above, ICA review risk, controlled goods and ITAR exposure, security clearance eligibility, cap table composition, apply at both levels but require different analysis at each. The consequences of getting the structure wrong can be material and difficult to remedy after the fact.

The most effective approach at either level is to engage experienced legal and technical advisors early, build regulatory assessment into the initial screening process rather than treating it as a closing condition, and resolve structural questions including LP composition, IP ownership, clearance eligibility and export control classification, before deal-specific pressures foreclose options.

For more information, please contact the authors, Sean Del Giallo, Paul Lalonde and Sandy Walker.

The authors would like to thank Diana Nakka for her contributions to this insight.

This article is part of our Financing Defence in Canada series. To read the previous article in the series, click here.