Big Tech companies have gutted a trio of promising artificial intelligence start-ups in the past six months, refining a new M&A playbook which threatens to push venture capitalists to the sidelines of the AI boom.
Chatbot-makers Inflection and Character. AI, and AI agent developer Adept, had together raised more than $2bn in funding before their top talent were hired by Microsoft, Google and Amazon respectively.
Following the trio of deals, Big Tech companies have gained the start-ups’ founders, researchers and engineers, as well as licences to their products. VCs, however, have ended up roughly where they started.
Their early exits are an ominous signal for other AI start-ups that are attempting to build their own large language models, the systems that underpin OpenAI’s ChatGPT and Google’s Gemini.
The deals will add to concerns among venture investors that the winners from the AI boom will be the biggest tech companies that can meet the multibillion-dollar costs of developing cutting-edge AI systems.
Earlier this month, Google agreed to hire Character. AI’s co-founders Noam Shazeer and Daniel De Freitas and license the start-up’s celebrity-impersonating chatbots. Character’s founders and other shareholders, the largest of which is Silicon Valley venture capital firm Andreessen Horowitz, will reportedly receive $2.5bn as part of the deal.
That values Character at 2.5 times its March 2023 price tag of $1bn, a respectable but unspectacular return for investors who have put nearly $200mn into the start-up since it launched in 2022.
Microsoft’s tie-up with Inflection and Amazon’s Adept deal were even less rewarding for the two start-ups’ VC backers, who recouped little more than their original investments, said people familiar with those transactions.
The deals made for “pretty decent” paydays for the founders who went to work for Big Tech, said Mike Volpi, a partner at venture firm Index Ventures, but they are “not good outcomes” for VCs.
The majority of start-ups fail, so VCs rely on a handful being so successful that their bad bets are covered many times over.
“VCs, especially those with larger funds, need outsized outcomes [and] 2.5-times your money . . . is really not very useful for a single company,” said Volpi, whose firm has invested in a number of AI companies, including Cohere and Mistral.
Less than two years after the launch of OpenAI’s powerful ChatGPT chatbot kicked off a flurry of AI investment, many founders who had quit their corporate jobs to launch start-ups have returned to the embrace of Big Tech companies.
Shazeer and De Freitas criticised Google’s sluggish pace when they left to launch Character in 2022 but have ultimately returned. A number of Adept’s leaders and Inflection founder Mustafa Suleyman were all Google researchers prior to launching their companies. They now work at Amazon and Microsoft respectively.
The absorption of the three companies by behemoth tech companies underscores how challenging scaling an AI start-up is. The resources required to train and run cutting-edge AI models are enormous and start-ups without an established distribution channel have struggled.
Those challenges are likely to be compounded in the next stage of AI development, according to David Cahn, a partner at venture firm Sequoia Capital.
Over the past year, start-ups have sought an edge in novel research techniques or better training data. “The next phase in the AI race is going to look different: it will be defined more by physical construction than by scientific discovery,” wrote Cahn in a recent blog, as AI companies race to build vast data centres costing billions of dollars apiece to build more powerful models.
That is likely to advantage Big Tech companies, which have increased annualised capital expenditure from $138bn to $229bn over the past year, he added.
Even start-ups which have remained independent are heavily reliant on Big Tech partnerships. Microsoft has committed $13bn to OpenAI; Amazon and Google have invested $6bn into Anthropic between them. Smaller players such as Cohere and Mistral have also partnered with Big Tech companies.
Access to Big Tech’s computing resources and customers provides “an inherent advantage” to start-ups building large language models, said Raviraj Jain, a partner at Lightspeed Venture Partners. While only a handful of companies can afford to compete at that level, he added, there was still room for venture-backed start-ups to build smaller AI models, applications and infrastructure.
Regulatory intervention may shift the balance again. Antitrust bodies in the US and Europe are probing deals involving Amazon, Google and Microsoft — despite efforts to structure the arrangements in ways which leave start-ups nominally independent. Last month, the UK’s Competition and Markets Authority announced a probe of Microsoft’s deal with Inflection.
VCs point out consolidation and flame-outs are typical in the early stages of a technology boom. The dotcom bust of the late 1990s did not prevent the internet becoming ubiquitous and the most popular consumer applications only arrived years after the advent of the smartphone.
“We are undoubtedly traversing a tricky period for venture capital because of the concentration of all the excitement in one sector,” Volpi said. “But there are hundreds of companies doing lots of interesting projects in AI land. In that big haystack, there will be some needles.”
