Google shook Silicon Valley last week by agreeing to pay $2.5 billion to license Character AI's technology and retain the company's two superstar co-founders and 20% of its employees. The deal came after AI developers Adept and Inflexion effectively sold themselves to Amazon and Microsoft, respectively, in recent months.
“It's kind of shocking to see a company that's raised so much money in such a short amount of time make this kind of hire to make an acquisition,” said Brent Queener, managing partner at Bonfire Ventures.
“This is unusual,” added Kyle Sanford, a venture analyst at PitchBook.
Character AI raised $150 million in venture funding last year and was valued at $850 million. The app has been a hit, ranking 15th in the entertainment category on Apple's App Store with 3 million downloads last month, according to Sensor Tower data.
But in reality, the startup has seen lackluster growth and negligible revenue, and its appeal as a chatbot that uses AI to create virtual characters that interact with users seems decidedly niche. The company just didn't have the momentum to raise a bigger funding round in today's hyper-competitive funding environment, according to 500 Global investor Iris Sun.
“On the surface, it looks like things are going well, but in reality, they're not,” Sun said. “In July, the mobile app made just $200,000, and its estimated revenue this year is only about $17 million, so it's not self-sustaining.”
Most of the founders and investors Business Insider spoke to for this article said Google has little interest in Character.AI's actual product — its real goal is to bring back the company's star co-founders, CEO Noam Chazier and President Daniel de Freitas, and compete with Microsoft, Amazon and other big tech companies that appear to be leading the race for AI talent.
“The dirty secret of the AI boom is that there's a huge bottleneck in terms of the number of world-class computer scientists and engineers who can really push the boundaries and innovate,” said Jack Selby, head of Peter Thiel's family office and managing partner at AZ-VC. “There are only a few thousand of these people available, and given how scarce they are, they're very expensive.”
Another motive is to avoid antitrust scrutiny, which has made it much harder to approve traditional mergers and acquisitions under the Biden administration. This week, a federal court ruled that Google violated U.S. antitrust laws in its search business. Last month, cybersecurity startup Wizz turned down a $23 billion takeover bid by Google's parent company, worried the deal wouldn't be approved.
“This could avoid some of the scrutiny and is quicker because there's no acquisition to be approved by the Federal Trade Commission or the Department of Justice,” said Steve Brotman, founder and managing partner at Alpha Partners.
“To challenge the deal, the FTC and DOJ would be forced to consider antitrust litigation that could take years to unwind. By the time the litigation is over, there's nothing left to unwind. So many acquirers are going down this path, whereas traditional M&A can take years to complete.”
VCs rethinking their relationships with founders
Traditionally, startups have raised money and given huge rewards to investors, employees and founders until they get acquired or go public — this everybody-wins model is how it usually works in Silicon Valley.
In the case of recent deals like Character AI, it's only the founders who are really celebrating: Shazier, who owns up to 40% of the company, stands to make up to $1 billion, according to The New York Times. And Shazier and de Freitas, who left Google in 2022 to complain about the company's growing bureaucracy, will have to return to their desks at the company. Meanwhile, the startup's 80% of employees who won't join Google are in limbo.
“Without the founders, they're gone and someone else has the keys to the car,” said S. Somaseghar, managing partner at Madrona Venture Group.
Most importantly, investors are getting roughly 2.5 times their return.
“This isn't an ideal situation for anyone,” PitchBook's Sanford said. “When investors put money into these companies, they're hoping for a 50x return. If they get 1.5x their investment in a few years, they won't be sad, but they probably won't be ecstatic.”
Venture capitalists own a piece of a startup, but they don't own the founders, and they're rethinking their relationships with founders as they are lured out of startups by big paydays, said Roy Bahat, an investor and principal at venture capital firm Bloomberg Beta.
“There will be a new standard of trust in the relationship between VCs and founders, because VCs have to trust that founders are looking out for their interests,” Bahat said. “It may also change the way some people think about contracts. They will have to come up with different ways to structure contracts so that founders can participate in the value they create if they can ultimately work wherever they want.”
Some founders say they would never consider exiting a startup early, even if the payday offered was huge.
“Personally, I'm not interested in doing anything like this because I feel like we're here to make an impact,” said Arvind Jain, CEO of AI assistant platform Glean, which has reportedly raised $250 million at a $4.5 billion valuation. “As long as we feel that remaining independent is the way to maximize our impact, that's what we want to do.”
But Cameron Lester, global co-head of technology, media and telecommunications investment banking at Jefferies, said deals like Google's Character AI deal are likely to continue, even if they are widely disliked.
“I think we'll see a lot of these companies emerge over the next few years,” Lester said. “We're talking to a variety of strategic companies — public companies, sponsored companies, venture firms — that are looking at these assets now and see this as a good way to hire AI talent in a hard-to-find talent environment.”
