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Depending on where you live in the investment world, the venture capital industry is either in raw health or facing an existential crisis.
Like most people in technology these days, startup investors have backed artificial intelligence on the hilt. The latest evidence comes with this week's news that Databricks, a software provider for collecting and analyzing large volumes of data, you are high another $10bn, one of the largest rounds of private investment.
Their willingness to put up the kind of big money that would require the involvement of Wall Street represents one of the biggest trends. investors they view the AI boom with a different swagger.
But to double it AI it has coincided with a period of intense global uncertainty about investment in general. The industry has not started to work in the way of excessive investment from the Zirp-period, which ends in 2021, when the interest rate policy brings more money to tech startups.
This left about $2.5tn locked up in private unicorns, or companies valued at $1 billion or more. At least, that's the combined value these companies claimed after their last promotion, according to PitchBook. When it comes to trying to monetize these chips through an initial public offering or the M&A market, the returns can be very small. How much business will be left standing after the calculation is difficult to tell.
First, consider the betting scale for AI. Data bricks willing to grow $3bn-$4bn in its latest round, but CEO Ali Ghodsi said investors offered $19bn (he decided to split the difference).
Given the high level of demand, Databricks' latest estimate doesn't seem out of the ordinary. At $52bn before the addition of new money, it was up from $43bn 15 months earlier and is almost equal to 17 times its annual operating profit – it's not hard to upset a business that is growing at 60 per cent a year.
Private equity funding rounds of $1bn or more used to be rare. It took the great will of SoftBank's Vision Fund and a handful of late-stage investment team experts to break the mold. Now, investors like Thrive Capital, which led Databricks around, are proud to have put up $1bn single-handedly.
Over the past two years, AI model builders OpenAI, Anthropic and Elon Musk's xAI have raised nearly $40 billion between them. Other sizeable investment rounds this week alone include a $500mn ConfusionAI search engine, and $333mn of Vultrpart of a new group of companies running specialized cloud data centers to support AI.
What makes this boom in private AI support even more remarkable is that it comes against the backdrop of a broader fall in investment. Compared to the boom year of 2021, before the interest rate cycle turned, the amount of venture capital invested two years later fell 55 percent to $161 billion, according to PitchBook. In the first nine months of this year, less than half as many investors have completed deals as in all of 2021.
Small, large funds are pumping ever-increasing amounts into a narrowing range of companies, almost all of them in AI: it's a long way from the model it's based on, spreading small amounts of seed investment across the board in the hope that the occasional big hit will offset the many misses.
But the concept of VC itself has changed. In many ways, the big private tech markets are now competing with Wall Street. Rates of return will certainly decline as large amounts of capital are put to work in mature companies, although successful investors will no doubt state that they stand to make better returns than equivalent amounts invested in other asset classes.
For many other investors, the situation has been too short. After a brief boom in 2021, IPOs and sales to strategic buyers have fallen off a cliff. With low returns, most VC investors don't want to put in more. Many startups that achieved unicorn status during the boom would rather cut costs and save money than recoup more money at a lower cost. It will take some time for this to work in the system, but the fact – that most of the cost of Zirp will no longer be supported – will be avoided.
Investors in the latest round of big AI funding will be hoping to avoid a similar fate. Companies like Databricks, which says it will turn cash flow positive this quarter, already appear poised for an IPO. That could make 2025 a pivotal year for the latest VC investment fad.
richard.waters@ft.com