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Roula Khalaf, Editor of the FT, selects her favorite stories in this weekly newsletter.
Depending on where you sit in the investment world, the venture capital business is either in rude health or facing an existential crisis.
Like many people in tech these days, start-up investors are backing artificial intelligence all the way. The latest evidence comes with news this week that Databricks, a provider of software to gather and analyze large amounts of data, has increased another $10bn, one of the largest private investment rounds ever.
Their willingness to put up the kind of large sums that once required the participation of Wall Street shows how some of the largest venture investors is navigating the AI boom with a different swagger.
But doubling up AI coincided with a period of severe indigestion for the world of startup investing in general. The industry has barely begun to work through a large overhang of investments from the Zirp period of venture – the period, which ends in 2021, when a zero-interest rate policy leads to a flood of capital in tech start-ups.
This leaves about $2.5tn stuck in private unicorns, or companies with a value of $1bn or more. At least, that’s the combined amount the companies claimed after their last fundraising, according to PitchBook. When it comes to actually trying to cash in on these chips through initial public offerings or the M&A market, the returns are likely to be much smaller. How much of the business was left standing after the last count was hard to say.
First, consider the size of the AI bet. Databricks began to raise $3bn-$4bn in its latest round, but chief executive Ali Ghodsi says investors are offering $19bn (he decided to roughly split the difference).
Given the overwhelming level of demand, Databricks’ latest valuation doesn’t look out of the ordinary. At $52bn before the addition of new cash, it was up from $43bn 15 months earlier and roughly equated to 17 times the annual revenue run-rate – hardly irresistible for a business that growing at 60 percent a year.
Private funding rounds of $1bn or more are rare. It took the big ambition of SoftBank’s Vision Fund and some specialized late-stage investment groups to break the mold. Now, investors like Thrive Capital, which led the Databricks round, pride themselves on putting up $1bn alone.
In the past two years, AI model builders OpenAI, Anthropic and Elon Musk’s xAI have raised nearly $40bn between them. Other large investment rounds this week alone include $500mn for Confusionan AI-powered search engine, and $333mn for Vultris part of a new group of companies running specialized cloud data centers to support AI.
What makes this surge in private backing for AI even more surprising is that it comes against the backdrop of a broader slump in venture capital. Compared to the boom year of 2021, before the interest rate cycle, the amount of venture capital invested two years ago fell by 55 percent, to $161bn, 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.
Fewer, larger funds pumping larger sums into a narrower range of companies, almost all of them in AI: this is a far cry from the model on which the venture was founded , to spread small amounts of investment seed corn widely in the hope that the occasional big hit will make up for the many misses.
But the concept of VC itself has changed. In many ways, the private capital markets for technology today rival Wall Street. Rates of return should fall when greater amounts of capital are employed in more mature companies, although successful investors will undoubtedly point out that they stand to make better returns than those of similar size. fund that invests in other asset classes.
For many other investors, the situation has become a little more critical. After a brief upswing in 2021, IPOs and sales to strategic buyers fell off a cliff. With less cash to return, many of the investors behind VC funds are reluctant to put in more. Many start-ups that achieved unicorn status during the boom would rather cut costs and save money than go back to raise more money at a lower cost. It will take time for it to work its way through the system, but the reality – that many Zirp valuations can no longer be supported – is inescapable.
Investors in the AI giant’s latest round of funding will hope to escape a similar fate. Companies like Databricks, which says it will be cash flow positive this quarter, are poised for an IPO. That could make 2025 a pivotal year for the latest VC investment trends.
