The value of private equity and venture capital-backed investments in generative AI companies more than doubled in 2023, defying the slump in overall M&A activity.
Generative AI investments by private equity firms reached an announced value of $2.18 billion in 2023 compared to the $1 billion prior-year total, according to S&P Global Market Intelligence data. The capital surge came as total private equity-backed M&A across all industries plunged in 2023.
In 2024, deal activity was off to a swift start, with the $250 million in private equity-backed investments recorded from Jan. 1 to Feb. 15 already exceeding the first-quarter 2023 total.
The potentially transformative applications of generative AI — a term for artificial intelligence-powered systems that can produce text and images based on user inputs — "gave investors something to be excited about," while an uncertain macroeconomic outlook and higher interest rates slowed deals in general, said Melissa Incera, a research analyst with S&P Global Market Intelligence 451 Research.
"This isn't just an incremental advancement, but a new wave of tech that is going to change the world and is horizontally impactful across much of the tech landscape," Incera said.
Frenzy builds
There has been a "frenzy" for generative AI investment built in the wake of the November 2022 launch of ChatGPT, the now widely used chatbot, Incera said. Private equity-backed investment peaked at $927.7 million in the third quarter of 2023, up from $121.5 million recorded in the prior-year period, according to Market Intelligence data.
The buzz around generative AI accelerated alongside private equity investment in the sector.
In the fourth quarter of 2023, the term AI was mentioned 2,398 times on the earnings calls of 159 S&P 500 companies, a nearly tenfold increase from the 241 mentions of the term on the prior-year earnings calls, when 52 companies in the index used the term, according to Market Intelligence's Trending Topics.
Private equity caution
Fast-rising valuations and heated competition from corporate strategic buyers for generative AI create crosswinds for private equity investors. Incera said high valuations in the sector threaten future returns for private equity but are less of a concern for strategic investors — largely other technology companies — which may prioritize relationships with generative AI developers above a return on capital.
"There's a limited amount of opportunities [for] all of these players that want to get in on the ground floor, and I think that's a huge piece of why these valuations are so astronomical," Incera said.
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Sounding a note of caution for investors, a report issued by The Carlyle Group Inc. in October 2023 drew a comparison between the rise of generative AI and the mass electrification of the US in the 1920s, stating that "investors aggressively bid up" the valuations for electric companies, while "far more economic value was being created by the companies buying that power."
Blackstone Inc. is also treading cautiously. The alternative asset manager is more focused on "derivative plays," including investments in the datacenter infrastructure that is rapidly scaling to accommodate the processing needs of AI, CFO Michael Chae said, speaking at a February conference.
"There's obviously a bit of a gold rush going on. We're not in the business of investing in early stage, high valuations in that space," Chae said.
Deal trends
Generative AI businesses headquartered in the US and Canada absorbed close to 45% of the total value of private equity-backed investments in the sector in 2023, with 11 deals aggregating $974.9 million. Europe came next with $608.6 million in announced value across six deals.
Most of the deal value in Europe was linked to a single funding round for German generative AI startup Aleph Alpha GmbH. The company's $500 million series B round was led by Robert Bosch Venture Capital GmbH, Schwarz Beteiligungs-GmbH and IPAI Management GmbH.
