AI: Investors brace for more 'AI Acqui-Hires'. RTZ #454

...more AI consolidations likely ahead

As I’ve discussed, we’ve now had at least three ‘AI Aqui-hires’ (aka ‘Take-under’) of Unicorn AI startups by various big tech companies. It of course started with Microsoft absorbing the key founders of Inflection, followed by Amazon doing a similar transaction with Adept, and most recently, Google’s relatively generous transaction with Character.ai, bringing the from ex-Googler founders, back into the fold.

Now it looks like private venture investors are leaning into these types of transactions. As the Information highlights in “Investors Undaunted by Spate of AI Acqui-Hires”:

“Thomvest Ventures was finishing an early-stage investment in an artificial intelligence startup when the San Francisco–based firm’s managing director, Don Butler, noticed Thomvest’s lawyer had made a subtle change to the fine print of the deal’s term sheet.”

“In a section outlining what would constitute a liquidation event for the startup—typically, a sale, initial public offering or bankruptcy—the lawyer had added “an exclusive and material license of the company’s intellectual property.” The language was inspired by a recent spate of unusual arrangements in which big tech companies hired most of the talent inside AI startups and paid hefty fees to license their technologies—but not hefty enough, in some cases, for investors to view them as winning deals.”

“The term-sheet change could put it ahead of other shareholders if there was a payout from such an event, though as with an initial public offering or merger, the investor isn’t guaranteed to get any money at all. Still, the change showed how investors are bracing for the possibility of more such outcomes—sometimes called acqui-hires.”

“The tweak to the Thomvest term sheet encapsulates how Silicon Valley seems to be reacting to some of the early, less-than-spectacular outcomes for startups in the AI business. There is caution, perhaps even a bit of nervousness, but overall startup investors say they remain as confident as ever that tech is on the cusp of major transformation driven by AI.”

“The optimism may stem partly from the fact that the recent acqui-hires weren’t all unequivocal flops for their investors. In March, Microsoft agreed to pay Inflection $650 million to make the AI startup’s models available for sale on Azure, Microsoft’s cloud service, at the same time that it hired two of Inflection’s co-founders and most of its staff.”

“The unusual arrangement stunned the venture capital industry. Inflection had raised $1.5 billion in VC funding and had been hailed a leader in AI. Its investors will still receive 1.1 to 1.5 times their initial investments, in part because the company likely hadn’t spent all of the cash it raised, The Information previously reported.”

“A handful of employees remain at the company, and its original investors could see additional returns if Inflection is successful at developing new AI products.”

“Since then, two more prominent AI companies, Adept AI and Character.AI, have struck similar deals with Amazon and Google, respectively. In Adept’s case, most investors got their money back but didn’t make a profit. Character’s deal was much rosier; its investors received at least 2.5 times their original investment, The Information reported.”

“But those kinds of returns are a far cry from the grand slams that are the holy grail for venture capitalists, or even the triples and home runs that are more common.”

“One reason for these deals, in the eyes of investors, is the difficulty that big tech companies face in getting large traditional acquisitions past antitrust regulators. The regulators have taken notice of the growing popularity of acqui-hires and other AI deals and have begun probing them.”

And more transaction like this are expected, as the Information outlines separately in “The Generative AI Startups That May Look for a Buyer”:

“Google’s complex deal to hire the founders and other researchers of Character.AI—the third such deal between a tech giant and an artificial intelligence startup in the past six months—raises a question: Which startup might be next?”

“Startups that collectively raised billions to develop their own AI models have found it difficult to compete against big tech companies with vast computing resources and large customer lists. But many startups are loaded with top-notch technical talent, making them attractive targets for firms that have been on the sidelines so far, such as Apple.”

“Prior to Google’s deal with Character, Microsoft and Amazon each struck similar deals with Inflection AI and Adept AI, respectively. Investors and executives said other large tech companies—including Salesforce, Oracle, Nvidia or newer players such as xAI or OpenAI—could make moves in coming months. Snowflake, for instance, has been discussing a partnership with model developer Cohere; such a partnership could lead to an acquisition.”

The piece goes onto outline 7 AI unicorn startups that may also see similar transactions ahead. More will likely be added to these types of lists.

All of this of course is in reaction to a tougher M&A regulatory environment, and the ever escalating need for higher amounts of AI capex to Scale AI to the next level. Not to mention the global AI talent race underway as an ongoing, critical input.

And of course the fact that we’re in the earliest days of this AI Tech Wave, with some unprecedented technology changes ahead up and down the AI tech stack above. AI ‘Acqui-hire’ transactions are likely to be more the norm than exception. Stay tuned.

(NOTE: The discussions here are for information purposes only, and not meant as investment advice at any time. Thanks for joining us here)