AI is crushing startup valuations for pre-ChatGPT companies

Five years ago, venture capitalists were pouring money into U.S. startups selling everything from lingerie subscriptions to scheduling software, giving them a billion-dollar valuation before most even turned a profit.

It was a frothy time for startups, fueled by a combination of cheap money and pandemic-spurred demand. But even after the Federal Reserve took a bit of a hit by starting to raise interest rates in 2022, many founders thought they could grow to their inflated valuations, investors told CNBC.

Then an app called ChatGPT came along.

“The ChatGPT moment was when people said, ‘Gee, the next generation of entrepreneurs, their coding language is spoken English,'” said Samir Kaul, a partner at venture capital firm Khosla Ventures, an early backer of OpenAI.

“Now you see 50 engineers doing what it would have taken 500 engineers five years ago,” Kaul said. “We’ve had to completely rethink how we value these businesses.”

While shares of public software companies like Sales force, ServiceNow And working day has been hammered this year due to the threat of artificial intelligence, a calmer reckoning has unfolded in private markets.

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ChatGPT’s arrival stranded in 2022 — effectively cut off from venture funding due to their inflated valuations and outdated technology, but not profitable enough for the public markets.

There are 857 U.S. startups valued at $1 billion or more, the threshold to be considered a “unicorn” company, according to PitchBook data. But nearly half of that group hasn’t raised new funds in the past three years, making those valuations outdated, according to the private markets data firm.

Startups that last raised in 2021 are now worth 68% less on average, while those that last raised in 2022 have seen a 52% decline, according to Pitchbook’s own valuation estimates.

As a result, more than 220 companies that reached billion-dollar valuations during the venture capital boom are now fallen unicorns, according to PitchBook, which provided a list of the companies exclusively to CNBC. Estimates are based on factors such as employee growth and comparisons to public companies.

“A lot of these companies are pre-AI, not only in their cost structure, but also in their products,” Mercury CEO Immad Akhund told CNBC. His company, which raised $200 million last month, provides banking services to a third of U.S. venture-backed startups.

“They’re definitely in a tough situation,” he said. “All the focus is on AI, so if you’re not an AI-driven company, you need very strong numbers to grow.”

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

Also included are podcast advertising stalwarts including powder supplement maker AG1 and robo-advisor pioneer Betterment, as well as online ticket marketplace SeatGeek.

These companies came of age in an environment that rewarded growth at mediocre valuations based on two general assumptions: interest rates would remain low and a startup could always be acquired for its engineering talent.

But the arrival of generative AI has reshaped the venture capital landscape, redirecting capital toward AI-native companies while preventing many older startups from justifying their earlier valuations.

Hardest hit are business software companies like scheduling startup Calendly, which represent the largest category among fallen unicorns. There are 75 software-as-a-service, or SaaS, companies that appear on PitchBook’s list, double the number of fintech companies, the second-largest group.

This reflects both the huge valuations of software startups during the venture capital boom of 2021 and the extent to which generative AI has destabilized the assumptions that underpin the sector.

David Zhu, a formerPorteDash engineering manager, said that after the “ChatGPT moment,” he looked at the software landscape – from startups to private credit-funded mid-sized companies to the largest public SaaS companies – and saw a seismic shift on the horizon.

“The thesis I had was that all workflow-focused SaaS companies will either be disrupted or dead in the next decade,” Zhu told CNBC.

The SaaS model, in which companies integrate into employee workflows and often bill the user, 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 companies’ sales and marketing teams.

According to Zhu, companies built before generative AI are weighed down by bloated staffing models and software designed for a pre-AI world, making it difficult to transform.

“Unless they do a 180-degree turn to rebuild the exact same thing from scratch, they will slowly fail,” Zhu said. “This means investors simply prefer to bet on new entrepreneurs at lower valuations rather than doubling down on older startups.”

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

A spokesperson for drone maker Skydio – estimated by PitchBook to have fallen $2.5 billion to $509 million – said in a statement: “This third-party speculation is false and not based on Skydio’s operations or the exponential growth we are seeing in revenue and customers. »

A few weeks later, Skydio announced that it had raised $110 million from existing investors, bringing its valuation to $4.4 billion.

An AG1 spokesperson did not provide a statement for this article, but after CNBC’s investigation, Reuters reported that the supplement maker was considering selling part or all of the company for a valuation of $2 billion. This figure would include 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 financing or a plausible IPO, the most likely exit for many fallen unicorns is an acquisition at a fraction of their former valuation, they say.

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

Although some startups might have avoided raising money because they generate significant profits, this is the exception to the rule, he said.

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

Some startups have had glimmers of a reset this year.

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

The same month, another fintech, Step, was acquired by YouTube star MrBeast for an undisclosed amount, leading investors to speculate that the purchase price was much lower than the roughly $500 million the startup raised before the deal.

“A lot of these companies just aren’t worth 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.

Valuations have increased about six-fold from the 2021 peak of 50 times future earnings, meaning a company with the same earnings is worth about 85% less in today’s market than it was five years ago, Falvey told CNBC.

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

But that assumption, which provided a floor for startup valuations during the boom, evaporated after AI coding tools allowed much smaller teams to create products — leaving exit opportunities few and far between.

The result is that post-GPT startups are running laps around their older competitors, according to Falvey. He called the investments made over the past three years “without a doubt the best” his company has made.

“We noticed that in 2023, the companies we invested in after ChatGPT were already making more money than most of the companies we invested in before ChatGPT,” Falvey said.

Generative AI could ultimately reduce the amount of capital required to build successful software companies, challenging one of the fundamental assumptions that fueled the venture capital boom of the last decade.

The disruption is likely only just beginning, as AI’s impact ripples across the entire corporate finance ecosystem, from venture capital to private credit to public giants.

Kaul says older software companies still rely on business models based on charging customers based on the number of employees using their products, an approach he believes will be undermined by AI as companies automate more white-collar work.

To survive, software providers will need to move toward outcome-based pricing models and AI-native infrastructure, he said.

“The question I ask every time one of them comes up is: Why can’t OpenAI or Anthropic or Google do this?” » said Kaul. “For most of them, the answer is, ‘They can.’