AI craze is distorting VC market, as tech giants like Microsoft and Amazon pour in billions of dollars
Amazon Web Services CEO Adam Selipsky speaks with Anthropic CEO and co-founder Dario Amodei during AWS re:Invent 2023, a conference hosted by Amazon Web Services, at The Venetian Las Vegas in Las Vegas on Nov. 28, 2023.
Noah Berger | Getty Images
Almost three years into a largely dormant IPO cycle, venture capitalists are in a tough spot.
The private market is dotted with richly valued artificial intelligence startups, including some that are described as generational companies. But venture firms in need of exits aren’t going to get relief from AI anytime soon.
That’s because, unlike prior tech booms, VCs aren’t at the center of this one. Rather, the biggest companies in the industry — Microsoft, Amazon, Alphabet and Nvidia — have been pouring in billions of dollars to fuel the growth of capital-intensive companies like OpenAI, Anthropic, Scale AI and CoreWeave.
With some of the most well-capitalized companies on the planet flinging open their wallets to fund the generative AI craze, the normal pressures to go public don’t apply. And even if they did, this batch of startups is nowhere near showing off the profitability metrics that public investors need to see before taking the plunge.
Tech giants have more than money. They’re also throwing in tangible benefits like cloud credits and business partnerships, packaging the types of incentives that VCs can’t match.
“The AI startups we talk to are having no problems fundraising at robust valuations,” Melissa Incera, an analyst at S&P Global Market Intelligence, told CNBC. “Many are still reporting having too much unsolicited investor interest at the moment.”
Add it all up and venture investors are maneuvering through a deep market distortion with no clear end in sight. U.S. VC exit value this year is on track to reach $98 billion, down 86% from 2021, according to an Aug. 29 report from PitchBook, while venture-backed IPOs are expected to be at their lowest since 2016. Traditional VCs are actively trying to play in AI, but they’re mostly investing higher up the so-called stack, putting money into nascent startups building applications that require far less capital than the infrastructure businesses powering generative AI.
So far in 2024, investors have pumped $26.8 billion into 498 generative AI deals, including from strategic investors, according to PitchBook. That continues a trend from 2023, when generative AI companies raised $25.9 billion for the full year, up more than 200% from 2022.
According to Forge Global, which tracks private market transactions, AI as a percentage of total fundraising jumped from 12% in 2023 to 27% so far this year. The average round for AI companies is 140% bigger this year compared to last, the data shows, while for non-AI companies the increase is only 10%.
Chip Hazard, co-founder of early-stage firm Flybridge Capital Partners, says investing dollars are shifting “up the stack” and that “enduring companies will be built at the application layer.”
That’s all going to take time to develop. In the meantime, startup investors continue to suffer from the fallout of the market turn that began in early 2022, when soaring inflation led the Federal Reserve to lift interest rates, pushing investors out of risky assets and into more conservative investments that finally offered yield.
Tech stocks have since bounced back, driven by Nvidia, whose chips are used in training most of the AI models, and other mega-cap stocks like Microsoft, Meta and Amazon. The Nasdaq hit a record in July before selling off a bit of late. But IPOs and pricey acquisitions have been few and far between, leaving venture firms with minimal returns for their limited partners.
“Managers are having a difficult time raising additional funds without delivering LP returns, especially because more liquid, lower-risk investments now have attractive yields thanks to high interest rates,” PitchBook wrote in its August report.
The one pure AI company that appears close to going public is Cerebras, a chipmaker founded in 2016 that’s backed by some traditional VCs including Benchmark and Foundation Capital. As a semiconductor company, Cerebras never reached the lofty valuations of the AI model developers and other infrastructure players, topping out at $4 billion in 2021, prior to the market’s downward tilt.
Cerebras said in late July that it had confidentially filed its IPO paperwork with the SEC. The company still hasn’t filed its public prospectus. A Cerebras spokesperson declined to comment.
When it comes to the foundational model companies, the astronomical valuations they quickly commanded put them in a very “different league,” outside of the realm of VCs, said Jeremiah Owyang, a partner at Blitzscaling Ventures.
It’s “very challenging for VCs to be promising any exits right now, given the market conditions,” Owyang said, adding that early-stage investors may not see returns for seven to 12 years on their newer bets. That’s for their companies that ultimately succeed.
Elbowing into big rounds
Firms like Menlo Ventures and Inovia Capital are taking another route in AI.
In January, Menlo disclosed that it was raising a so-called special purpose vehicle (SPV) — called Menlo Inflection AI Partners — as part of a $750 million funding round in Anthropic in a deal that valued the company at more than $18 billion. Since Anthropic’s launch in 2021, Amazon has been the company’s principal backer as it tries to keep pace with Microsoft, which has poured billions of dollars into OpenAI and is reportedly part of an upcoming funding round that will value the ChatGPT creator at over $100 billion.
Menlo had previously invested in Anthropic in 2023 at a valuation of about $4.1 billion. To put in more money at a much higher price, Menlo had to go outside of its main $1.35 billion fund that closed last year. In raising an SPV, a venture firm typically asks for LPs to put money into a separate fund dedicated to a specific investment, rather than a portfolio of companies. Menlo filed to $500 million for the SPV.
In July, rival startup Cohere, which focuses on generative AI for enterprises, announced a $500 million funding round from investors including AMD, Salesforce, Oracle and Nvidia that valued the company at $5.5 billion, more than doubling its valuation from last year.
Cohere confirmed to CNBC that part of the financing, as well as some of its previous fundraising, came through an SPV. Inovia, based in Montreal, organized the latest SPV, and Shopify CEO Tobias Lutke was one of the participants.
Representatives from Menlo and Inovia didn’t respond to requests for comment.
Some investment banks have also put together SPVs to allow multiple investors to pool capital into a hot company. JPMorgan Chase told CNBC that clients “have been able to access several leading AI investments” through the bank’s Morgan Private Venture unit.
Still, for investors to get a return there has to be an IPO at some point, as the regulatory environment makes it virtually impossible for big tech companies to orchestrate significant acquisitions. And companies like Microsoft, Alphabet, Amazon and Nvidia can be plenty patient with their investments — they have a combined $280 billion in cash and marketable securities on their balance sheets.
IPO pipeline will ‘continue to build’
The other potential path for liquidity is the secondary market, which involves selling shares to another investor.
Elon Musk’s SpaceX, which reportedly valued itself at over $200 billion in a recent employee tender offer, has enabled investor shares through secondary transactions. That may be what’s eventually in store for some investors in xAI, Musk’s 18-month-old AI startup, which is already valued at $24 billion after raising a $6 billion round in May.
But SpaceX is an outlier. For the most part, secondary transactions are viewed as a way for founders and early investors to cash out a portion of their stock in a high-valued company, not a way for VCs to generate returns. For that they need IPOs.
SpaceX’s Polaris Dawn Falcon 9 rocket sits on Launch Complex 39A of NASA’s Kennedy Space Center on August 26, 2024 in Cape Canaveral, Florida.
Joe Raedle | Getty Images
Michael Harris, global head of capital markets at the New York Stock Exchange, told CNBC recently that NYSE is in dialogue with “a number of AI-focused companies” and said that, “as the industry evolves we’d expect that pipeline to continue to build.”
A select few AI companies have hit the public market this year. Astera Labs, which sells data center connectivity to cloud and AI infrastructure companies, debuted on the Nasdaq in March. The company is valued at about $6.5 billion, down from $9.5 billion after its first day of trading.
Tempus AI, a health-care diagnostics company backed by Google, went public in June. The stock is up around 50% from its debut, valuing the company at $8.6 billion.
The IPO floodgates never opened, though, and high-profile AI companies aren’t even talking about going public.
“Unless there is a dramatic shift in market sentiment, I would be hard-pressed to see why these AI startups would put themselves in the public spotlight when they can keep growing privately at such favorable terms,” said S&P’s Incera. Going public “would only amp up pressure to show returns or reduce spending, which for a lot of them is not a feasible ask at this point in the maturity curve,” she said.
Most venture investors are bullish on the potential for generative AI to eventually create big returns at the application layer. It’s happened in every other notable tech cycle. Amazon, Google and Facebook were all web applications built on top of internet infrastructure. Uber, Airbnb and Snap were a few of the many valuable apps built on top of smartphone platforms.
John-David Lovelock, an analyst at Gartner and a 35-year veteran of the IT industry, sees a big opportunity for generative AI in the enterprise. Yet, in 2024, only 1% of the trillion dollars spent on software will be from businesses spending on generative AI products, he said.
“There is money being spent on certain GenAI tools and the few applications that exist,” Lovelock said. “However, broad-scale rollout of GenAI within the broad enterprise software catalogue of products has not yet occurred.”
Tesla sales in China dropped to a three-year low in October, raising concerns the electric vehicle maker could see its first full-year sales decline in the country this year.
Fierce competition from local rivals such as NIO and Li Auto — both reporting this week — and a bruising price war in the face of a down economy pushed Tesla’s China sales to 26,006 last month. The U.S. automaker’s share in the Chinese EV market shrank to 3.2% in October from 8.7% in September.
“Tesla is getting surrounded by a swarm of Chinese automakers — from above, below, left and right,” Michael Dunne, CEO of Dunne Insights and auto analyst, told CNBC. “Like a swarm of drones, each is taking some sales from the company with a target on its back.”
Tesla’s newest direct competitor in the upper echelon of the Chinese EV market is Xiaomi. The smartphone maker’s YU7 sports utility vehicle and SU7 sedan posted record sales in October despite accidents that raised concerns about the cars’ safety.
The auto newbie sold nearly 109,000 cars in the third quarter — compared with 170,000 for Tesla. Xiaomi’s EV unit turned a profit for the first time.
Late bloomer Leapmotor is pressuring Tesla, too. The Chinese EV startup was founded in 2015, but only this year started beating out its local peers in terms of sales and stock price. Analysts credit its in-house production for keeping costs down. Its C10 mid-sized SUV is priced at roughly half of a Model Y. Leapmotor also has a JV partnership with Europe’s Stellantis.
Leading EV sales in China this year is the Geely Geome Xingyuan. The hatchback is not a direct competitor to Tesla since it serves the cheaper end of the market with its sub $10,000 price tag. Yet it is an indication of where Chinese buyers are at — budget-conscious but looking for value.
The Geome Xingyuan’s success also highlights another trend — traditional automakers such as Geely making inroads in EVs. That trend is turning Huawei into a more notable Tesla rival. The Chinese tech giant partners with old-line carmakers like Seres, Chery, and Beijing Auto. The Aito M8, a Seres model, has become popular among high-end SUVs.
Despite the steep competition, Tesla’s Model Y is still holding up, ranking 6th in the overall market. At Tesla’s annual general meeting this month, Musk said he expected the Chinese to approve the company’s “Full-Self Driving” software in early 2026.
Yet analysts say Tesla needs to refresh its models to keep pace with its local rivals.
Tu Le, founder of consultancy firm Sino Auto Insights, sees 2026 as a “pivotal year” for Tesla in China.
“Reality is catching up to Tesla in China,” Tu said. “Tesla has done an admirable job via price cuts, non-price-cut price cuts and other tricks to maintain sales of almost five and four-year-old cars versus some of the world’s most advanced EVs. But not keeping up with the Xiaomi’s, BYD’s and XPeng’s seems to be finally starting to show itself in its monthly sales.”
Last month, Tesla reported its total third-quarter revenue increased 12% from a year earlier to $28.10 billion, following two straight periods of declines.
Even with the overall revenue growth, Tesla’s third quarter was marked by a continuing sales slump in Europe, driven partly by competition from EV makers like Volkswagen and BYD.
On a cold November evening in Shanghai in 2020, the world’s largest IPO was abruptly canceled by Chinese regulators.
It was Ant Group, the fintech affiliate of tech giant Alibaba. The company’s founder Jack Ma, one of China’s most famous billionaires, was under scrutiny for comments seemingly criticising the country’s financial regulators.
What followed was four years of pressure on Ma’s empire.
Since the IPO cancelation, more than $400 billion has been wiped off Alibaba’s value, even with a more recent rally. In the months after the failed public listing, Ma retreated from the public eye and Alibaba, China’s biggest e-commerce player, looked down and out, with management and structure changes bearing little fruit. The moves were not characteristic of the grit the company had shown in the past and a far cry from its strong position now.
But those who know Ma know never to count him out.
“The hallmark of Jack and his personality is that he never gave up,” Brian Wong, a former Alibaba executive and author of “The Tao of Alibaba,” told CNBC.
Wong features in my new show “Built for Billions,” in which I explore Alibaba’s most testing moments and delve into how it grew to become one of the world’s biggest tech companies and one of the most advanced artificial intelligence players.
Understanding Alibaba
I’ve been covering tech for more than a decade with much of my focus centering on China. I lived in the world’s second-largest economy for three years, from October 2018 to December 2021 when Alibaba was undergoing this significant shift. The company’s reach cannot be overstated from its humble beginnings in 1999 as a business to business online marketplace in the early days of the internet.
Now Alibaba’s business touches everything from food delivery to global e-commerce, cloud computing and artificial intelligence. Nowhere is the company’s brand and scale more evident than during Singles Day, an annual shopping event pioneered by Alibaba that sees huge discounts and deals across its platforms. What was once a single day of discounts has now become a more prolonged event that runs several weeks.
I have attended Alibaba’s Singles Day in both Shanghai — where it featured a huge gala with celebrities and music performances — and at its headquarters in Hangzhou. The whole company is mobilized as billions of dollars are transacted across its platforms in a short space of time. Those experiences provided a real insight into the scale of the company.
Alibaba has sometimes been compared to U.S. tech giant Amazon. But it’s not an apples-to-apples comparison.
“Alibaba now, is seen as a serious player in technology, not just an e-commerce company,” Duncan Clark, an early advisor to Alibaba and chairman of consultancy firm BDA China, told CNBC’s “Built for Billions.”
Pressure and reinvention
After the Ant Group IPO cancelation, Alibaba and indeed all of China’s tech sector faced a reckoning. Beijing began cracking down on domestic tech firms by tightening regulation.
One popular view was that Beijing was concerned about the power the country’s entrepreneurs were wielding.
Ma’s empire endured tightened regulations and even a nearly $3 billion antitrust fine in 2021.
There was a level of soul searching taking place at the company that was now battling a tougher domestic market with a weak consumer and rising challenges from players like PDD and JD.com. How could Alibaba reinvigorate growth? And was Jack Ma done for good?
When I left China in 2021, I was struck by how fixated international markets were with Ma. It was as if his reappearance served as a sign of Alibaba’s standing with the Chinese government. For instance, Alibaba’s stock would jump if Ma was spotted somewhere.
This overshadowed what was happening in the background. Alibaba had undergone one of the biggest restructures in history. But it wasn’t changing the giant’s fortunes. Daniel Zhang, who had succeeded Ma as CEO and eventually chairman some years prior, unexpectedly announced plans to step down in 2023. His successors were two well-respected veterans, current CEO Eddie Wu and President Joe Tsai.
They steadied the ship, refocused the company on its core e-commerce business, while simultaneously investing in AI. The results were a sharp improvement in business, particularly in more recent quarters.
Was Ma gone for good? It seemed not. In February, Ma was among a handful of entrepreneurs who met with Chinese President Xi Jinping in a rare meeting.
“He’s in his early 60s now, but he’s still pretty vibrant. He has homes and yachts and all that stuff. But one senses that he’s not done yet,” Clark said.
Alibaba quietly turns into AI giant
Amid the turmoil and revival, Alibaba was quietly investing in artificial intelligence behind the scenes. In fact, since 2016 it had been a priority.
“Acceleration happened, really during … the covid years 2019, 2021 when they really started to build their own foundational models and their own chips,” Mark Greeven, professor of management innovation at the International Institute for Management Development told “Built for Billions.”
When OpenAI’s ChatGPT hit the world in late 2022, Alibaba was ready just months later with its own AI offering.
Alibaba’s approach was different to some of its U.S. rivals, instead focusing on open source or open weight AI models which are free for developers to download and use. The company’s models are now among some of the most popular globally for developers to use.
CEO Wu has cemented Alibaba’s commitment to its reinvention as an AI company. In his first letter to employees after taking the reins, Wu called for Alibaba to return to the startup mindset and set two strategic priorities: “user first” and “AI-driven.”
The focus on AI has benefitted the company’s cloud business. It also comes at a time when AI development is being framed as a race between U.S. and Chinese companies and Alibaba is emerging as one of China’s key players.
“Wherever you look, whatever you touch, China is moving closer towards that vision of dominating AI race by 2030, Alibaba is participating and being an important player,” Ashley Dudarenok, a China digital expert and investor told “Built for Billions.”
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