OpenAI closes a 6.6 billion round of funding. 

October 2024

In the news recently, it was announced that OpenAI,  the company that created ChatGPT, is in 

the midst of a closing a 6.5 billion funding round. 

There are many interesting tidbits of this story but lets start with the main points. 

• OpenAI, has experienced incredible revenue growth - $3.7 billion is expected for 2024 and they expect to reach $11.6 billion in 2025. 

• OpenAI’s valuation has risen dramatically—from $30 billion to $150 billion, in a year.

• Even with the 3.7 billion they are expected to bring in, their high operating costs mean that they will still end the year with a 5 billion deficit. This 9 billion operating cost is an extremely high burn rate, and comes from the costs of running its AI services, specifically the cloud infrastructure to process all the LLM requests. 

• OpenAI needs capital to continue to innovate with AI and also just to stay operational. 

Purchasing the right to future profits isnt a typical way to invest in a company. When companies raise funds, they usually exchange a portion of the company for the capital. The company then uses this capital to fuel growth, hire talent, build infrastructure, launch new products, and ultimately to grow the company even more.  The more money they raise, the more shares they have to issue, and the ownership stakes of existing shareholders get diluted (though hopefully offset by the company’s increased value).

The unusual aspect of the deal is OpenAI has 2 years to convert to a Public Benefit Company (PBC), and if they don’t, the investment received from Thrive Capital is converted into debt. Thrive would no longer have the right to future profits from OpenAI and would be repaid back the investment. 

This is essentially a safeguard for investors, ensuring that if OpenAI fails to generate significant profits or change its structure, they will still get their money back as debt repayment, instead of losing their investment.

Why does OpenAI need to convert to a PBC? 

“OpenAI is a non-profit artificial intelligence research company.  Our goal is to advance digital intelligence in the way that is most likely to benefit humanity as a whole, unconstrained by a need to generate financial return. Since our research is free from financial obligations, we can better focus on a positive human impact.”

Developing AI systems like ChatGPT requires enormous computational resources, talent, and infrastructure, all of which are costly. So investors are necessary to provide funding. 

Investors that invest in companies do so seeking some sort of a financial return in exchange for their capital, which they expect to come from the growth and profitability of the company they invest in. And non-profits, by definition, are not designed to generate profits for investors, which means there’s no financial return for them. 

This is why in 2019, it evolved from a nonprofit to a “capped-profit” entity  This model allowed OpenAI to raise money from investors while still placing a limit on how much profit those investors would earn (though its cap is super high), ensuring that the organization stayed aligned with its mission to focus on its mission to develop safe AI for the benefit of humanity.  

Switching to a PBC would mean the investors could not only get a portion of the profits, they could convert their investment into equity in the company, be in the boardroom and have voting power.  The shift is also partly motivated by investors wanting a simpler way to cash out and achieve significant returns.  And remember, In most deals, investors take on the risk of losing their money if the company doesn’t succeed. Here, Thrive has a safety net—if OpenAI doesn’t go for-profit, they get their money back.

The ability to lock in the $150 billion valuation adds extra value since OpenAI’s valuation could keep climbing. If things don’t work out as planned, Thrive still has the safety net of getting its money back, thanks to the debt conversion feature. Thrive Capital’s deal with OpenAI is smart because it gives them two pathways to profit: either through future capped profits or by converting their investment into equity, if OpenAI becomes a for-profit company.

This deal shows how creative financing can be, especially in fast-moving sectors like artificial intelligence, where the future is uncertain, but the potential rewards are huge.

MG Tigler did a great writeup about this here:  https://spyglass.org/the-art-of-the-openai-deal/. 

Sources: 

https://openai.com/index/introducing-openai/

https://www.wsj.com/tech/ai/openais-complex-path-to-becoming-a-for-profit-company-bad21a42

https://www.nytimes.com/2024/09/27/technology/openai-chatgpt-investors-funding.html?ref=spyglass.org