AI startup deals are gaining popularity—is that a good thing?

This is not the year many in the dealmaking industry were hoping for for M&A, as deal flow remains moderate at best and investors seek liquidity.

But there may be some hope for the tech industry’s current darling—AI—as significant deals (and some “non-deals”) have been struck and more high-profile startups are being named as targets of Big Tech’s warming, acquisition-oriented nature.

The numbers confirm the growing M&A interest and rumors. Deal activity involving AI startups increased significantly in Q2. 65 AI startups were acquired during the quarter, according to Crunchbase data, up 55% from Q2 last year and up 15% from Q1, when 55 deals were made.

What’s more, there have already been more than two dozen deals in the current quarter—not counting, of course, the “nonexclusive licensing agreement” that Google announced with AI chatbot startup Character.ai. That deal involved buying out investors and bringing the co-founders back to Google. It wasn’t an acquisition (or so we were told), which is something we’re seeing more and more of in the tech world and could herald tough times ahead for AI.

The pace of transactions is accelerating

While mergers and acquisitions are starting to show signs of a revival for VC-backed startups, this year hasn’t seen the avalanche of deals many expected after a slow 2023, due to a range of factors from interest rates to regulations.

AI startups appear to be bucking the trend—just as they did when venture capital funding declined—with 145 M&A deals involving VC-backed startups so far this year, a pace far ahead of last year’s 189 deals.

The second quarter saw the biggest AI deals of the year, including Nvidia buying Run:AI for $700 million and Deci AI for $300 million within a day of each other. The quarter also saw JFrog buy AI management platform Qwak for $230 million.

Financial problems?

However, the reasons for the sharp increase in the number of transactions may be different and not necessarily beneficial for the generative AI sector.

There’s no denying that many deals are being made for strategic reasons as large companies try to outdo their competitors in the AI ​​race. It’s also arguable that some startups may be struggling with cash as the costs of building large language models and other AI platforms rise while revenues grow slowly.

While these aren’t technically M&A deals (mostly due to regulations), there’s clearly been a rise in the number of large tech companies acquiring both the technology and employees of some of the larger startups

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

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

Finally, just last month, Google struck a “non-exclusive” licensing deal 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 comes after reports emerged that Elon Musk’s xAI was considering buying Character.AI to help develop Grok AI models.

While it was reported that Character employees were told that investors were taking the stock at a valuation of $2.5 billion — up from the $1 billion the company was valued at after closing its $150 million Series A round led by Andreessen Horowitz — and all of the deals included a return to investors, it was still a far cry from the 10x or more returns they were likely hoping for when they invested just a year or two ago.

That’s likely because many seem to realize that the resources and infrastructure costs associated with being a leader in the AI ​​industry are too great to generate significant revenue — especially in the face of competition from the deep pockets of big tech companies — and are now looking for a way out.

As more investors come to this conclusion, we can expect to see more M&A deals (even those specifically designed not to look like M&A deals) as larger tech companies look to add technology and talent to their growing AI ambitions.

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Illustration: House of Guzman