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Depending on where you are in the investment world, the venture capital business is either in poor health or facing some sort of existential crisis.
Like many people in the tech sector today, startup investors have backed artificial intelligence to the hilt. The latest evidence came with the news this week that Databricks, a provider of software for collecting and analyzing large volumes of data, has lifted another $10 billion, one of the largest private investment rounds in history.
Their willingness to contribute large sums that would once have required Wall Street’s participation shows how some of the largest companies venture investors They are navigating the rise of AI with a distinctive swagger.
But double the bet AI has coincided with a period of serious indigestion for the world of seed investing in general. The industry has only just begun to claw its way through an immense investment glut from the Zirp era of venture, the period that ended in 2021, when a zero interest rate policy brought a flood of capital to tech startups.
This has left around $2.5 trillion trapped in private unicorns, or companies with a valuation of $1 billion or more. At least, that’s the combined value these companies claimed after their latest fundraisings, according to PitchBook. When it comes to trying to capitalize on these chips through initial public offerings or the M&A market, the returns are likely to be much lower. It’s hard to say how much of the venture business will be left standing after the eventual reckoning.
First, let’s consider the magnitude of the bet on AI. Data bricks proposed to raise Between $3 billion and $4 billion in its latest round, but CEO Ali Ghodsi said investors had offered $19 billion (he decided to roughly split the difference).
Given the overwhelming level of demand, Databricks’ latest valuation doesn’t seem far-fetched. Before the addition of the new cash, it was $52 billion, up from $43 billion 15 months earlier and roughly equivalent to 17 times its annualized revenue rate, not at all outrageous for a business growing at 60 percent a year.
Private financing rounds of $1 billion or more were once a rarity. It took the enormous ambition of SoftBank’s Vision Fund and a handful of specialized late-stage investment groups to break the mold. Now, investors like Thrive Capital, which led the Databricks round, are proud to have put up $1 billion alone.
Over the past two years, AI model makers OpenAI, Anthropic, and Elon Musk’s xAI have raised nearly $40 billion between them. Other major investment rounds this week alone included $500 million for perplexitya search engine powered by artificial intelligence, and 333 million dollars for Vultrpart of a new group of companies running specialized cloud data centers to support AI.
What makes this rise in private support for AI even more notable is that it comes against the backdrop of a broader collapse in venture investing. Compared to the boom year of 2021, before the interest rate cycle changed, the amount of venture capital invested two years later had plummeted 55 percent, to $161 billion, according to PitchBook. In the first nine months of this year, fewer than half as many investors completed deals than in all of 2021.
Fewer and larger funds are pumping ever-larger amounts into a shrinking range of companies, almost all of them AI—a far cry from the model the company was founded on, of widely distributing small amounts of investment corn seeds. hoping that an occasional big success would make up for many failures.
But VC’s self-concept has changed. In many ways, private capital markets for technology now rival Wall Street. Rates of return will necessarily fall as much larger amounts of capital are put to work in more mature companies, although successful investors will no doubt point out that they can earn better returns than similarly sized funds investing in other asset classes.
For many other venture investors, the situation has become almost critical. After a brief boom in 2021, IPOs and sales to strategic buyers have plummeted. With less cash being returned, many of the investors backing venture capital funds are unwilling to put up more. Many startups that achieved unicorn status during the boom would rather cut costs and conserve cash than come back to raise more money at a lower valuation. It will take time for this to work in the system, but the reality (that many Zirp valuations are no longer supportable) will be inevitable.
Investors in the AI giant’s latest funding round are hoping to escape a similar fate. Companies like Databricks, which says it will generate positive cash flow this quarter, already appear ready for an IPO. That could make 2025 a pivotal year for the latest venture capital investment craze.
richard.waters@ft.com