AI is crushing startup valuations for pre-ChatGPT firms

Five years ago, venture capitalists were pouring money into American startups selling everything from underwear subscriptions to scheduling software, garnering them billion-dollar valuations, many without even making a profit.

It was a frothy period for startups, fueled by a combination of cheap money and increased demand due to the pandemic. But even after the Fed gets a little frothy by starting to raise interest rates in 2022, many founders believe they can achieve inflated valuations, investors told CNBC.

Then came an application called ChatGPT.

“The ChatGPT moment was when people said, ‘Holy smokes, next generation entrepreneurs, coding languages ​​are spoken in English,'” he said Samir Kaul, He is a partner at startup Khosla Ventures, one of the early backers of OpenAI.

“You’re now seeing 50 engineers doing what it took 500 engineers to do five years ago,” Kaul said. “We had to completely rearrange the way we valued these companies.”

Shares of publicly traded software companies sales force, ServiceNow And Working day A quieter reckoning is taking place in private markets, which have been hit this year by the threat of artificial intelligence.

Artificial intelligence is blowing it up funnel More than $250 billion invested in OpenAI and Anthropic ahead of the mega IPO expected this year has left hundreds of startups founded before ChatGPT’s arrival in 2022 in a difficult situation; Venture funding has effectively been cut off due to their inflated valuations and outdated technologies, but they are not profitable enough for public markets.

There are 857 startups in the U.S. valued at $1 billion or more; This creates the threshold to be considered a “unicorn” company. Pitch Book data. But nearly half of that group hasn’t raised new financing in the past three years, causing those valuations to become stale, according to the private market data firm.

According to Pitchbook’s own valuation estimates, the value of startups that last grew in 2021 is now 68% less on average, while the value of startups that last grew in 2022 is down 52%.

As a result, more than 220 companies that reached billion-dollar valuations during the startup boom are now fallen unicorns, according to PitchBook, which made the list of companies available exclusively to CNBC. Estimates are based on factors such as headcount growth and comparisons with publicly traded companies.

“Many of these companies are pre-AI, not just in terms of their cost structures but also in terms of their products,” Mercury CEO said. Immed Akhund he told CNBC. His company, which raised $200 million in funding last month, provides banking services to one-third of early-stage venture-backed firms in the United States.

“They are definitely in a difficult situation,” he said. “All the attention is on AI, so unless you’re an AI-first company, you need really strong numbers to upgrade.”

The list of falling unicorns includes well-known brands brighter, Farmer’s Dog, Rothy’s, Brooklyn And SavageLingerie company founded by musician Rihanna. The companies were part of a wave of direct-to-consumer firms built in the hope that digital retailers could earn software-like margins.

Also included are the mainstays of podcast advertising, including the powder supplement manufacturer AG1 and robo-advisor pioneer Betterment, as well as online ticket marketplace CouchGeek.

These companies matured in an environment that rewarded growth with nosebleed valuations based on two general assumptions: interest rates would stay low, and a startup could always be acquired for its engineering talent.

But the advent of generative AI has redrawn the startup landscape by directing capital to AI-native firms, making it impossible for many legacy startups to justify their previous valuations.

Hardest affected are enterprise software companies, such as planning startups CalendlyRepresenting the largest category among falling unicorns. PitchBook’s list includes 75 software-as-a-service, or SaaS, companies, which is twice the number of fintech companies, the next largest group.

This reflects both the massive valuations commanded by software startups during the 2021 startup boom and the extent to which generative AI is destabilizing the assumptions underpinning the industry.

David Zhuan old oneDoor Indicator The head of engineering said he looked at the software landscape after the “ChatGPT moment” — from startups to private loan-financed midsize firms to the largest publicly traded SaaS companies — and saw a seismic shift on the horizon.

“My thesis was that all workflow-focused enterprise SaaS companies will either disrupt or disappear in the next decade,” Zhu told CNBC.

The SaaS model, in which companies insert themselves into employees’ workflows and are often charged by the user, is particularly threatened by the rise of autonomous agents. After leaving DoorDash, where he led more than 200 engineers, Zhu Reevo, An artificial intelligence platform that automates enterprise sales and marketing teams.

According to Zhu, companies founded before generative AI are pressured by bloated staffing models and software designed for a pre-AI world, making it difficult for them to transform themselves.

“Unless they take a sharp 180-degree turn to rebuild the same thing from scratch, they will gradually fail,” Zhu said. “What this means is that investors are choosing to bet on new startups at lower valuations rather than doubling down on old startups.”

An AG1 spokesperson did not provide a statement for this article, but following CNBC’s investigation, Reuters reported said the supplement maker plans to sell some or all of the company at a valuation of $2 billion. The report stated that this figure would also include AG1’s debt.

Investors and founders say if a company hasn’t raised financing since 2021 or 2022, it’s unlikely to do so again. Without access to venture capital or a reasonable initial public offering ramp, the most likely exit for many fallen unicorns would be an acquisition well below their former valuations, they say.

“When we see companies not growing, that’s a red flag,” said PitchBook analyst Andrew Akers, adding that it usually means their growth is slow or even negative.

While some start-ups have refrained from raising funds because they are making solid profits, this is the exception to the rule, he said.

“I think there are a lot of dominoes below the surface that are going to fall,” Akers said.

There have been signs of a reset among some startups this year.

In February, Investment and savings application Stash, acquired Singapore-based everything app Grab has an enterprise value of $425 million, below the nearly $660 million put in by investors into throughout the life of the company.

That same month, another fintech, Step, was acquired by YouTube star MrBeast for an undisclosed amount; This led investors to estimate that the purchase price was well below the startup’s approximately $500 million. raised before agreement.

“A lot of these businesses aren’t worth that much anymore, so you’re seeing them being bought at huge discounts,” he said. Ryan Falvey It is owned by Restive Ventures, which invests in fintech companies.

Falvey told CNBC that valuations are down about six times from the 2021 peak of 50 times future revenues, meaning a company with the same revenue is worth about 85% less in today’s market than it was five years ago.

Before the reset, a startup could often be sold to a larger tech company looking to buy out the smaller firm’s engineers for around $2 million per coder, according to Khosla Ventures’ Kaul. He said the value of a company with 100 engineers would be at least $200 to $300 million.

But this assumption, which provided a basis for startup valuations during the boom, has evaporated as AI coding tools allow much smaller teams to produce products and exit opportunities remain few and far between.

As a result, according to Falvey, post-GPT startups are circling around their old rivals. He said the investments made in the last three years were “undoubtedly the best” his firm has ever made.

“By 2023, we realized that the companies we invested in post-ChatGPT were making more money than most of the companies we invested in before ChatGPT,” Falvey said.

Generative AI could ultimately reduce the amount of capital needed to launch successful software companies, challenging one of the core assumptions that has fueled the startup boom of the past decade.

The shakeup is likely just beginning as the impact of AI ripples through the business finance ecosystem, from venture to venture. Private loans to public giants.