In the dynamic world of artificial intelligence (AI), startup founders are rapidly securing funding, leading to record-breaking valuations in the sector.
Recently, Perplexity secured $63 million, effectively doubling its worth to over $1 billion within a three-month span, while Foundry debuted with a valuation of $350 million. Additionally, Cognition, a nascent AI coding firm, is rumored to be valued at a staggering $2 billion.
Despite the flurry of headlines celebrating these massive funding rounds, a complex reality is unfolding behind the scenes. Consider the case of Lightning AI, an open source AI development platform, which, after raising $40 million in Series B funding in July 2022, is deliberately pausing further fundraising. CEO William Falcon expressed concerns that an inflated valuation might hinder the company’s ability to hire top AI professionals.
Falcon expressed his desire to avoid a situation where recruiting becomes a challenge due to high valuation, underscoring the importance of aligning the company’s revenue with its potential worth.
High valuation can sometimes pose a risk to stock option value, reducing the potential for significant gains. Moreover, should a startup need to accept a ‘down round’ of funding, employee equity could suffer. In Silicon Valley, where equity forms a significant part of compensation, the valuation of a startup is intricately linked to its hiring strategy.
Matthew Schulman, CEO of data compensation platform Pave, elaborated on the double-edged sword of high valuations: they suggest capital and stability but may also raise doubts about the real value of equity offerings among potential employees.
As AI startup valuations skyrocket, startups find themselves in a delicate juggling act: needing capital for AI development while competing for a limited pool of AI talent.
David Katz of Radical Ventures observed that the quickening pace of funding rounds is pressuring startups to secure talent before valuations rise further, complicating recruitment efforts.
Lightning AI’s Falcon noted that job candidates are increasingly inquisitive about a company’s financials, asking direct questions about valuation, revenue, customer base, and future financial plans.
Some of the largest AI startups are struggling to meet soaring expectations. For instance, if OpenAI, valued at an estimated $90 billion, were to grow tenfold, it would need to reach the market cap akin to that of Amazon—a lofty ambition. This raises questions about the feasibility of such growth and its implications for employee equity.
A high valuation could be a recruiting disadvantage
May Habib, CEO of Writer, also subscribes to the notion that high valuation can be a deterrent in talent acquisition. She has observed an increase in candidates’ inquiries about the company’s valuation and future fundraising rounds, suggesting that excessive valuations may discourage prospective hires.
A tech recruitment specialist from the Bay Area delved into an AI startup’s financial and product strategies during an interview, reflecting the growing trend of candidates scrutinizing potential employers more thoroughly.
Aishwarya Srinivasan, a senior advisor at Microsoft for Startups, emphasized the importance of assessing risks when joining a startup, including valuation, product roadmap, business model, and the founders’ preparedness for success.
Valuation-related concerns extend to equity dilution during funding rounds. Habib highlighted the challenge of attracting top talent when valuations rise and equity gets diluted.
Muddu Sudhakar, CEO of Aisera, warned that a down round can be devastating for an AI startup, negatively impacting both the company’s reputation and its employees.
One CEO says no valuation is too big if the business is healthy
Renen Hallak, CEO of Vast Data, contends that a hefty valuation isn’t problematic if the business growth matches or surpasses the valuation increase. He cites Vast Data’s valuation, which doubled to over $9 billion, as justified by the company’s growth trajectory. Hallak also mentioned that Vast Data allows employees to benefit from higher valuations through secondary rounds, where they can sell some equity at the new share price.
Jett Fein, a general partner at VC firm Headline, argued that the correlation between hiring and valuation isn’t straightforward. While top talent gravitates towards companies with high valuations, there can be instances where a promising company might be overvalued, which discerning candidates will investigate.
Transparency is crucial in reconciling the interests of AI startup founders and their employees. Candidates from both the Bay Area and New York reported that AI startups they interviewed with were quite transparent about their financial prospects.
Finding the right balance
Turck, a partner at FirstMark, mentioned that not all companies can afford to defer fundraising, highlighting the advantageous position of those who can focus on attracting top talent without immediate funding needs.
Falcon of Lightning AI believes his company’s current stance on valuation aids in accessing superior talent. He acknowledges that this dynamic may shift with future funding rounds, where the challenge will be to maintain alignment between valuation and revenue to ensure continued growth and value for employees.
