When Microsoft first invested $1 billion in OpenAI in 2019, the deal has received no more attention than your average VC round. The startup market was booming, and artificial intelligence was one of many areas attracting mega-caps, alongside electric vehicles, advanced logistics and aerospace.
Three years later, the market is very different.
Funding for startups slumped following collapsing public market multiples for high-growth and loss-making tech companies. The exception is artificial intelligence, specifically generative AI, which refers to technologies focused on the automated production of text, visual, and audio responses.
No private company is hotter than OpenAI. In November, the San Francisco-based startup introduced ChatGPT, a chatbot that went viral for its ability to create human-like responses to user queries on almost any topic.
Microsoft’s once-underappreciated investment is now a major talking point, both in venture capital circles and among public shareholders, who are trying to figure out what it means for the potential value of their shares. Microsoft’s cumulative investment in OpenAI reportedly increased to $13 billion and the startup’s valuation reached around $29 billion.
That’s because Microsoft isn’t just opening up its big portfolio for OpenAI. It is also the arms dealer, as the exclusive provider of computing power for OpenAI research, products and programming interfaces for developers. Startups and multinationals, including Microsoft, are rushing to integrate their products with OpenAI, which means massive workloads running on Microsoft’s cloud servers.
Microsoft is integrating the technology into its Bing search engine, sales and marketing software, GitHub coding tools, Microsoft 365 productivity bundle, and Azure cloud. Michael Turrin, analyst at Wells Fargosays all of this could add up to more than $30 billion in new annual revenue for Microsoft, with about half coming from Azure.
What does this mean for Microsoft’s investment and its broader arrangement?
“It’s so good that I have investors asking me how they got there, or why OpenAI would even do that,” Turrin said in an interview.
However, the financial implications are anything but simple.
OpenAI was founded in 2015 as a non-profit association. The structure changed in 2019, when two senior executives issued a blog post announcing the formation of a “capped profit” entity called OpenAI LP. The current setup prevents early investors in the startup from making more than 100 times their money, with lower returns for later investors, such as Microsoft.
Once Microsoft’s investment is repaid, Microsoft will receive a percentage of OpenAI LP’s profits up to the agreed cap, with the rest going to the nonprofit, an OpenAI spokesperson said. A Microsoft spokesperson declined to comment.
Greg Brockman, co-founder of OpenAI and one of the authors of the blog post, wrote in a 2019 Reddit Comment that, to investors, the system “seems proportionate to what they could get by investing in a fairly successful startup (but less than they would get by investing in the most successful startups of all time!).”
It’s a model unheard of in Silicon Valley, where maximizing returns has long been the priority of the business community. It also doesn’t make much sense to Elon Musk, who was one of the founders and early backers of OpenAI. Several times this year, Musk has tweeted his concerns about OpenAI’s unconventional structure and its implications for AI, especially given Microsoft’s level of ownership.
“OpenAI was created as an open source (that’s why I named it ‘Open’ AI), a non-profit company to act as a counterweight to Google, but now it’s become a closed source company and at maximum profit effectively controlled by Microsoft,” Musk tweeted in February. “That’s not what I wanted at all.”
Brockman said on Reddit that if OpenAI succeeds, it could “create orders of magnitude more value than any company to date.” As a major OpenAI investor, Microsoft would benefit.
Besides its investment, building on OpenAI has the potential to help Microsoft dramatically reverse its fortunes in AI, where it stumbled publicly and failed to build a meaningful business on its own. Microsoft has removed the Clippy assistant from Word, Cortana from the Windows taskbar and its chatbot Tay from Twitter.
Unlike areas such as advertising or security, Microsoft hasn’t disclosed the scale of its AI business, although CEO Satya Nadella said in October that revenue from its Azure Machine Learning service had doubled during four consecutive quarters.
If nothing else, working with OpenAI gave Nadella bragging rights. Here’s what he said at Microsoft’s annual shareholder meeting in December, a month after ChatGPT launched:
“When I think of Azure, one of the things we’ve done, actually, even in the context of ChatGPT, which is one of the most popular AI applications today, guess what? It’s all formed on the Azure Supercomputer.”
In February, Microsoft held a press event at its Redmond, Wash., headquarters to announce new AI-powered updates to its Bing search engine and Edge browser. Altman was one of the guest speakers.
It’s been a bumpy ride since then, as the Bing chatbot had some high-profile and scary conversations with users, and it also provided incorrect answers when launched. Fortunately for Microsoft, Google’s rollout of its rival Bard AI service was disappointing, leading employees to describe it as “rushed” and “sloppy”.
Despite early misfires, enthusiasm for new technologies based on Large Language Models, or LLMs, is palpable in the tech industry.
At the heart of OpenAI’s bot is an LLM called GPT-4 that learned how to compose natural-sounding text after being trained on numerous online news sources. Microsoft has an exclusive license to GPT-4 and all other OpenAI models, the OpenAI spokesperson said.
There are many other LLMs available.
Last month, Google said he had given some developers early access to a LLM called PalM.
Startups AI21 Labs, Aleph Alpha and Cohere offer their own LLMs, as do supported by Google Anthropogenic, which has chose google as his “preferred” cloud provider. Like Altman and Musk, Anthropic co-founder Dario Amodei, who previously served as vice president of research at OpenAI, expressed concerns about the unbridled power of AI.
In 2021, Anthropic registered in Delaware as a public benefit corporation, signifying an intent to positively impact society even as it seeks profits.
“We were and are focused on developing innovative structures to provide incentives for the safe development and deployment of AI systems and we will have more to share about this in the future,” a spokesperson said. ‘Anthropic to CNBC in an email.
Across the industry, one thing is clear: this is just the beginning.
Quinn Slack, CEO of code research startup Sourcegraph, said he hadn’t seen evidence that the OpenAI partnership had given Microsoft a noticeable advantage, even though he called OpenAI a top LLM vendor.
“I don’t think people should look at Microsoft and say they’ve totally locked in OpenAI and OpenAI is doing their bidding,” Slack said. “I really believe that the people there are driven to create amazing technology and make it as widely used as possible. They see Microsoft as a great customer, but not someone who is controlling. hope it stays that way.”
OpenAI has many skeptics. Late last month, the nonprofit Center for Artificial Intelligence and Digital Policy asked the Federal Trade Commission to block OpenAI from releasing new commercial versions of GPT-4, describing the technology as “biased, misleading and presenting a risk to privacy and public safety”.
When considering potential OpenAI exits, Microsoft – which does not hold a seat on the OpenAI board – would be the natural acquirer given its tight entanglement. But that kind of deal would likely attract regulatory scrutiny, due to concerns about AI and stifling competition from Microsoft. By remaining an investor and not becoming an owner of OpenAI, Microsoft could avoid Hart-Scott-Rodino criticism from US competition regulators.
“I’ve been there. It’s painful,” said David Zilberman, partner at Norwest Venture Partners.
Based on its current valuation, the most likely path for OpenAI is an eventual IPO, said Scott Raney, managing director of Redpoint Ventures.
According to data from PitchBook, OpenAI is on track to generate $200 million in revenue this year, up 150% from 2022, and then $1 billion in 2024, which would imply 400% growth.
“When you raise to a $30 billion valuation, it’s kind of like there’s no going back at this point,” Raney said. You say, “Our plan is to be a large, independent, stand-alone business.”
The OpenAI spokesperson said it has no plans to go public or be acquired.
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