AI is crushing startup valuations for pre-ChatGPT companies

Five years ago, venture capitalists were pouring money into American startups selling everything from lingerie subscriptions to scheduling software, pouring billion-dollar valuations before most of the companies had turned a profit.

It was a buoyant time for startups, supported by a combination of cheap money and pandemic-boosted demand. But even after the Federal Reserve eased some of the turmoil by starting to raise interest rates in 2022, many founders believed they could grow to inflated valuations, investors told CNBC.

Then an app called ChatGPT appeared.

“The ChatGPT moment was when people said, ‘Hey, next generation of entrepreneurs, their coding language is English,'” said Sameer Kaur, a partner at venture firm Khosla Ventures and an early supporter of OpenAI.

“What used to take 500 engineers five years ago now takes 50 engineers to do,” Kaul said. “We had to completely rethink how we value these companies.”

Stocks of public software companies have performed well, but sales force, ServiceNow and working day This year has been tough due to the threat of artificial intelligence, but a quieter calculation is unfolding in the private market.

The AI ​​boom that has pumped more than $250 billion into OpenAI and Anthropic ahead of their expected mega IPOs this year has left hundreds of startups founded before ChatGPT’s arrival in 2022 stranded, effectively cut off from venture funding due to their inflated valuations and outdated technology, yet not making enough money on the public markets.

According to PitchBook data, there are 857 U.S. startups with valuations of $1 billion or more, the threshold for being considered a “unicorn” company. But nearly half of the groups have not raised new capital in the past three years, making their valuations outdated, according to the private market data firm.

According to PitchBook’s own valuation estimates, the value of startups that last raised money in 2021 is now down 68% on average, and the value of startups that last raised money in 2022 is now down 52%.

As a result, more than 220 companies that reached $1 billion valuations during the venture boom are now fallen unicorns, according to PitchBook, which provided the list exclusively to CNBC. This estimate is based on factors such as employee growth and comparisons with publicly traded companies.

“Many of those companies are at a pre-AI stage, not only in their cost structure but also in their products,” Mercury CEO Imad Akhund told CNBC. His company, which raised $200 million in funding last month, provides banking services to one-third of America’s venture-backed early-stage companies.

“They’re definitely in a difficult situation,” he said. “There is so much focus on AI that if you are not an AI-first company, you need to hit very strong numbers.”

The list of fallen unicorns includes such well-known brands as Glossier, The Farmer’s Dog, Rothy’s, Brooklinen, and Savage X Fenty, the lingerie company founded by musician Rihanna. These companies were part of a wave of direct-to-consumer companies founded on the promise that digital retailers could capture software-like margins.

Also included are podcast advertising powerhouses such as powdered supplement maker AG1 and robo-advisor pioneer Betterment, as well as online ticket marketplace SeatGeek.

These companies grew in an environment where growth was rewarded with nosebleed valuations based on two broad assumptions. That is, interest rates remain low and startups are always available to acquire engineering talent.

However, the advent of generative AI has changed the venture landscape, with funding directed toward AI-native companies while many older startups can no longer justify their previous valuations.

Hardest hit are enterprise software companies like scheduling startup Calendly, which represent the largest category of fallen unicorns. There are 75 software-as-a-service (SaaS) companies on PitchBook’s list, which is twice as many as the next largest group, fintech companies.

This reflects both the huge valuations software startups received during the 2021 venture boom and how generative AI has destabilized the assumptions underpinning the sector.

David Zhu, formerdoor dash After the “ChatGPT moment,” the head of engineering said he looked across the software landscape, from startups to private credit-funded midsize companies to the largest publicly traded SaaS companies, and saw seismic shifts on the horizon.

“My thesis was that all workflow-driven enterprise SaaS companies would collapse or disappear within the next 10 years,” Zhu told CNBC.

The SaaS model, where companies embed themselves into employees’ workflows and are often billed by users, is particularly threatened by the rise of autonomous agents. After leaving DoorDash, where he led more than 200 engineers, Zhu founded Reevo, an AI platform that automates sales and marketing teams for companies.

Zhu said companies founded before generative AI are under the weight of bloated staffing models and software designed for a pre-AI world, making it difficult to transform themselves.

“Unless you do a 180-degree turnaround to rebuild the exact same thing from scratch, you’re going to fail slowly,” Zhu said. “What this means is that investors would rather bet on a new entrepreneur at a lower valuation than double down on an old startup.”

Most of the 20 fallen unicorns covered by CNBC either did not respond to multiple requests for comment or declined to comment.

A spokesperson for drone maker Skydio, whose value is estimated by PitchBook to have fallen from $2.5 billion to $509 million, said in a statement: “This third-party estimate is incorrect and is not based on Skydio’s business or the rapid revenue and customer growth we are seeing.”

A spokesperson for AG1 did not issue a statement for this article, but after a CNBC investigation, Reuters reported that the supplement maker was considering selling part or all of the company at a valuation of $2 billion. This figure also includes AG1’s debt, the report said.

If a company hasn’t raised money since 2021 or 2022, it’s unlikely to do so again, investors and founders say. Without access to venture capital or reasonable IPO accretion, the most likely exit for many fallen unicorns will be to be acquired at a fraction of their old valuations, they say.

“It’s a red flag when a company doesn’t raise money,” said Andrew Akers, an analyst at PitchBook, adding that it usually means a company’s growth will be slow or even negative.

Some startups may have avoided raising money because they generate solid profits, but that’s the exception, he said.

“I think there’s a lot of dominoes falling beneath the surface,” Akers said.

This year, there are signs of a reset among some startups.

In February, investment and savings app Stash was acquired by Singapore-based everything app Grab for an enterprise value of $425 million, less than the roughly $660 million investors had invested in the company over its lifetime.

That same month, another fintech company, Step, was acquired by YouTube star Mr. Beast for an undisclosed sum, leading investors to speculate that the deal was far less than the roughly $500 million the startup had raised before the deal.

“A lot of these companies aren’t worth that much anymore, which is why you’re seeing them being acquired at deep discounts,” said Ryan Falvey of Restive Ventures, which invests in fintech companies.

Falvey told CNBC that valuations have compressed about six times since their peak in 2021, when they were valued at 50 times future sales, meaning that companies with the same sales are worth about 85% less in the current market than they were five years ago.

Before the reset, startups were often sold to big tech companies looking to acquire engineers from smaller companies for about $2 million per programmer, said Kaul of Khosla Ventures. A company with 100 engineers would be worth at least $200 million to $300 million, he said.

But this assumption, which provided a lower bound on startup valuations during the boom, evaporated after AI coding tools enabled much smaller teams to develop products, leaving little opportunity for exit.

As a result, post-GPT startups are orbiting older competitors, Falvey said. He said the investments made in the past three years were “by far the best” his company had ever made.

“We realized that by 2023, the companies we invested in after ChatGPT were already more profitable than most of the companies we invested in before ChatGPT,” Falvey said.

Generative AI could ultimately reduce the amount of capital needed to start a successful software company, challenging one of the central assumptions that fueled the venture boom of the past decade.

The shakeout is likely just beginning, as the impact of AI is rippled across the business financing ecosystem, from venture firms to private credit to large public companies.

Kaul said older software companies still rely on business models built around charging customers based on the number of employees using their products, and he believes this approach will be undermined by AI as companies increasingly automate white-collar tasks.

He said software providers must move to outcome-based pricing models and AI-native infrastructure to survive.

“The question I ask every time they present is why can’t OpenAI, Anthropic, Google do this?” Kaur said. “For most of them, the answer is ‘yes’.”