Investors Pour $27.1 Billion Into AI Start-Ups Amid Downturn

For the past two years, many tech start-ups have struggled to stay afloat, with some cutting costs, selling themselves, or shutting down. However, those focused on artificial intelligence (AI) have thrived.

The AI Boom Continues

The AI boom, which began in late 2022, stands as a strong counterpoint to the broader start-up downturn. Investors poured $27.1 billion into AI start-ups in the United States from April to June, accounting for nearly half of all U.S. start-up funding in that period, according to PitchBook, which tracks start-ups. In total, U.S. start-ups raised $56 billion, up 57 percent from a year earlier and the highest three-month haul in two years.

Notable Funding Rounds

AI companies are attracting significant funding reminiscent of 2021, when low interest rates pushed investors to take risks on tech investments. In May, CoreWeave, a cloud computing services provider for AI companies, raised $1.1 billion, followed by $7.5 billion in debt, valuing it at $19 billion. Scale AI, a data provider for AI companies, raised $1 billion, valuing it at $13.8 billion. xAI, founded by Elon Musk, raised $6 billion, valuing it at $24 billion.

Such financing rounds have boosted the industry’s overall deal-making by dollar amount and number of deals, said Kyle Stanford, a research analyst at PitchBook. “It’s not declining anymore,” he said. “The bottom has already fallen out.”

Shifting Investor Sentiment

The activity has prompted some venture capital investors to change their message. Last year, Tom Loverro, an investor at IVP, predicted a “mass extinction event” for start-ups and encouraged them to cut costs. Last week, he declared that era over and christened this time the “Great Reawakening,” encouraging companies to “pour gas” on growth, particularly around AI. “The AI train is leaving the station & you need to be on it,” he wrote on X.

The Origins of the AI Boom

The start-up downturn began in early 2022 as many money-losing companies struggled to grow as quickly as they did during the pandemic. Rising interest rates also pushed investors toward less risky investments. To compensate for dwindling funding, start-ups slashed staff and scaled back ambitions.

Then, in late 2022, OpenAI, a San Francisco AI lab, kicked off a new boom with the release of its ChatGPT chatbot. Excitement around generative AI technology, which can produce text, images, and videos, sparked a frenzy of start-up creation and funding. “Sam Altman canceled the recession,” joked Siqi Chen, founder of the start-up Runway Financial, referring to OpenAI’s chief executive. Mr. Chen said his company, which makes finance software, was growing faster because “A.I. can do the job of 1.5 people.”

The Cost of AI Development

Despite AI's efficiencies, building AI systems is costly. AI-focused start-ups need vast amounts of powerful computer chips and cloud storage. An analysis of 125 AI start-ups by Kruze Consulting, an accounting and tax advisory firm, showed that these companies spent an average of 22 percent of their expenses on computing costs in the first three months of the year—more than double the 10 percent spent by non-AI software companies in the same period.

“No wonder V.C.s are throwing money into these companies,” said Healy Jones, Kruze’s vice president of financial strategy. While AI start-ups are growing faster than others, he said, “they clearly need the money.”

Future Outlook

For investors who back fast-growing start-ups, there is little downside to being wrong about the next big thing, but there is enormous upside in being right. The potential of AI has generated significant hype, with prominent investors and executives predicting that the market for AI will be bigger than those for smartphones, personal computers, social media, and the internet.

Mr. Stanford of PitchBook said competition from big tech companies, including Microsoft and Amazon, might affect AI start-ups’ ability to raise enormous sums of money. Large deals like the one struck by xAI were outliers and are unlikely to be repeated in the second half of the year. “That can’t happen forever,” he said.