AI craze getting funded by tech giants, distorting traditional VCs

Almost three years into a largely dormant IPO cycle, venture capitalists are in a tough spot.

The private market is dotted with richly valued artificial intelligence startups, including some that are described as generational companies. But venture firms in need of exits aren’t going to get relief from AI anytime soon.

That’s because, unlike prior tech booms, VCs aren’t at the center of this one. Rather, the biggest companies in the industry — Microsoft, Amazon, Alphabet and Nvidia — have been pouring in billions of dollars to fuel the growth of capital-intensive companies like OpenAI, Anthropic, Scale AI and CoreWeave.

With some of the most well-capitalized companies on the planet flinging open their wallets to fund the generative AI craze, the normal pressures to go public don’t apply. And even if they did, this batch of startups is nowhere near showing off the profitability metrics that public investors need to see before taking the plunge.

Tech giants have more than money. They’re also throwing in tangible benefits like cloud credits and business partnerships, packaging the types of incentives that VCs can’t match.

“The AI startups we talk to are having no problems fundraising at robust valuations,” Melissa Incera, an analyst at S&P Global Market Intelligence, told CNBC. “Many are still reporting having too much unsolicited investor interest at the moment.”

Add it all up and venture investors are maneuvering through a deep market distortion with no clear end in sight. U.S. VC exit value this year is on track to reach $98 billion, down 86% from 2021, according to an Aug. 29 report from PitchBook, while venture-backed IPOs are expected to be at their lowest since 2016. Traditional VCs are actively trying to play in AI, but they’re mostly investing higher up the so-called stack, putting money into nascent startups building applications that require far less capital than the infrastructure businesses powering generative AI.

So far in 2024, investors have pumped $26.8 billion into 498 generative AI deals, including from strategic investors, according to PitchBook. That continues a trend from 2023, when generative AI companies raised $25.9 billion for the full year, up more than 200% from 2022.

According to Forge Global, which tracks private market transactions, AI as a percentage of total fundraising jumped from 12% in 2023 to 27% so far this year. The average round for AI companies is 140% bigger this year compared with last, the data shows, while for non-AI companies the increase is only 10%.

Chip Hazard, co-founder of early-stage firm Flybridge Capital Partners, says that investing dollars are shifting “up the stack” and that “enduring companies will be built at the application layer.”

That’s all going to…