AI Startup Deal-Making Gaining Momentum

This has not been the year many in the deal-making industry were hoping for when it came to M&A activity, as deal flow remains tepid at best and investors search for liquidity.

However, tech’s current darling — AI — may be offering hope with notable deals (as well as some “non-deals”) being made and more big-name startups being bandied about as targets for the warming acquisitive nature of Big Tech.

The numbers bear out the rising M&A interest and chatter. Deal activity involving AI startups kicked up pretty significantly in Q2. The quarter saw 65 AI-related startups bought — per Crunchbase data — a jump of 55% from Q2 last year and a 15% increase from Q1 which saw 55 deals.

What’s more, the current quarter has already seen more than two dozen deals consummated — of course not even counting the “non-exclusive licensing agreement” Google announced with AI chatbot startup Character.ai. That agreement included buying out its investors and bringing its co-founders back to Google. It wasn’t an acquisition (so we’re told), something we are seeing more and more in the tech world and could portend difficult times ahead for AI.

Deal pace quickens

While M&A is starting to show more signs of life for VC-backed startups, this year has not seen the avalanche of deals many expected after a slow 2023 due to a variety of factors ranging from interest rates to regulations.

AI-related startups seem to be bucking that trend — just as they did the declining venture funding trend previously. This year has already seen 145 M&A deals involving VC-backed startups, a pace that is easily ahead of last year’s which saw only 189 total deals.

The second quarter saw the year’s largest AI deals, including Nvidia buying Run:AI for $700 million, as well as Deci AI for $300 million within a day of each other. The quarter also included JFrog buying AI management platform Qwak for $230 million.

Money problems?

However, the reasons for the surge in deal-making may be varied and not entirely positive for the generative AI sector specifically.

There’s no denying many deals are getting completed for strategic purposes as large companies strive to get ahead in the AI race. There’s a solid case to be made that some startups could be running into a cash crunch as the expense to create large language models and other AI-related platforms mounts and revenue is slow to grow.

While not technically M&A deals (mainly for regulatory reasons) there clearly has been an uptick in big tech swallowing up both the technology and employees of some good-sized startups

It started in March when Microsoft agreed to pay Inflection AI approximately $650 million in a licensing deal and hired away most of its staff while buying out investors.

In June, Amazon struck a similar deal with Adept AI for about $330 million. (The Federal Trade Commission is probing both the Microsoft and Amazon deals to see if the deals were structured to avoid government approval.)

Finally, just last month Google also came to a “non-exclusive” licensing agreement with AI chatbot startup Character.ai for its LLM technology, and also brought the company’s co-founders back to Google — where they were before starting Character.ai.

The Google deal came about after it was reported that Elon Musk’s xAI was considering buying Character.AI to help with its Grok AI models.

While it was reported that Character’s staff was told investors would be bought out at a $2.5 billion valuation — an uptick from the $1 billion the company was valued at after closing a $150 million Series A led by Andreessen Horowitz — and all the deals saw money distributed back to investors, it was far from the 10x-or-more return most probably were hoping for when they invested just a year or two ago.

That’s likely because many seem to be coming to the realization that the resources and infrastructure costs associated with being a leader in the AI space are too much to overcome to generate meaningful revenue — especially competing against the bottomless pockets of big tech — and are now looking for an exit.

As more investors come to such realizations, expect more M&A deals (and those specifically structured to not look like M&A deals) to happen as larger tech players look to add tech and talent to their growing AI ambitions.