Investors pour $27.1 billion into artificial intelligence startups, defying a downturn

San Fransisco: For two years, many unprofitable tech startups have cut costs, sold themselves or gone out of business. But the ones focused on artificial intelligence have been thriving.

Now the AI boom that started in late 2022 has become the strongest counterpoint to the broader startup downturn.

Investors poured $27.1 billion into AI startups in the United States from April to June, accounting for nearly half of all U.S. startup funding in that period, according to PitchBook, which tracks startups. In total, US startups raised $56 billion, up 57 per cent from a year earlier and the highest three-month haul in two years.

AI companies are attracting huge rounds of funding reminiscent of 2021, when low interest rates pushed investors away from taking risks on tech investments.

In May, CoreWeave, a provider of cloud computing services for AI companies, raised $1.1 billion, followed by $7.5 billion in debt, valuing it at $19 billion. Scale AI, a provider of data for AI companies, raised $1 billion, valuing it at $13.8 billion. And xAI, founded by Elon Musk, raised $6 billion, valuing it at $24 billion.

Such financing rounds have boosted the industry’s overall deal-making by dollar amount and number of deals, said Kyle Stanford, a research analyst at PitchBook.

“It’s not declining anymore,” he said. “The bottom has already fallen out.”

The activity has prompted some venture capital investors to change their message. Last year, Tom Loverro, an investor at IVP, predicted a “mass extinction event” for startups and encouraged them to cut costs. Last week, he declared that era over and christened this time the “Great Reawakening,” encouraging companies to “pour gas” on growth, particularly around artificial intelligence.

“The AI train is leaving the station & you need to be on it,” he wrote on the social platform X.

The startup downturn began in early 2022 as many money-losing companies struggled to grow as quickly as they did in the pandemic. Rising interest rates also pushed investors to chase less risky investments. To make up for dwindling funding, startups slashed staff and scaled back their ambitions.

Then in late 2022, OpenAI, a San Francisco AI lab, kicked off a new boom with the release of its ChatGPT chatbot. Excitement around generative AI technology, which can produce text, images and videos, set off a frenzy of startup creation and funding.

“Sam Altman canceled the recession,” joked Siqi Chen, founder of the startup Runway Financial, referring to OpenAI’s CEO. Chen said his company, which makes finance software, was growing faster than it otherwise would have because “AI can do the job of 1.5 people.”

Yet even as AI creates efficiencies, it is costly to build. Startups focused on AI need enormous stores of powerful computer chips and cloud storage.

An analysis of 125 AI startups by Kruze Consulting, an accounting and tax advisory firm, showed that the companies spent an average of 22 per cent of their expenses on computing costs in the first three months of the year — more than double the 10 per cent spent by non-AI software companies in the same period.

“No wonder VCs are throwing money into these companies,” said Healy Jones, Kruze’s vice president of financial strategy. While AI startups are growing faster than other startups, he said, “they clearly need the money.”

For investors who back fast-growing startups, there is little downside to being wrong about the next big thing, but there is enormous upside in being right. AI’s potential has generated deafening hype, with prominent investors and executives predicting that the market for AI will be bigger than the markets for the smartphone, the personal computer, social media and the internet.

Stanford of PitchBook said competition from big tech companies including Microsoft and Amazon might also affect AI startups’ ability to raise enormous sums of money. Large deals like the one struck by xAI were outliers and are not likely to be repeated in the second half of the year.

“That can’t happen forever,” he said.