ARK Venture Commentary

Friday, Feb 24th 2023

Commentary

Artificial Intelligence (AI) Infiltrates Megacap Tech

Both Alphabet and Microsoft announced new AI-driven search engine upgrades.[1] Microsoft is building off its $10 billion investment in OpenAI while Alphabet reportedly invested almost $400 million into Anthropic, an OpenAI competitor.[2]

ARK’s take: Language model-based AI systems do pose a competitive threat to Google’s search engine business, a high margin $160 billion per year near-monopoly.[3] At the very least Bing’s entry into the market should pressure margins given the expense of querying an AI language model. The larger threat to Google, however, is the potential for a structural shift in user behavior as AI begins to natively integrate into endpoint software. Why go to a search engine to find a stock photo for your graphic design, when you can ask your graphic design software to source or generate that image directly via a natural language interface?

Venture Capital Assets Begin to Reflect Market Reality[4]

Stripe is reportedly raising $2.5 billion in new equity at 40% off the valuation it commanded when it raised money in 2021.[5] Over the same timeframe Adyen, a comparable publicly traded company, traded down a similar amount.[6]

ARK’s take: Stripe’s high-profile down round [7] is indicative of valuation markdowns sweeping across the venture landscape. This is true even for companies that have sufficient cash reserves to avoid raising additional money as reflected by secondary market transactions occurring at a discount to previous rounds. We believe valuations that reflect current market conditions are healthy for venture as they allow investors to put new money to work and should increase deal flow liquidity throughout the first half of 2023.

Do Capped Upside Rounds Reflect a New Fundraising Strategy?

Microsoft’s $10 billion investment in OpenAI was heavily structured. Microsoft enjoys a disproportionate share of the profits upfront but reportedly can not reap more than a rough 10x return on its capital. [8]

ARK’s take: Though for Microsoft and other strategic investors structured investments that cap the ultimate upside could make sense, venture funders will need to think carefully about how they underwrite these deals. The venture capital model relies on high returns concentrated in a very small number portfolio companies. According to ARK’s research, uniformly capping upside potential at 10 times across a large sample of individual venture investments with measured exit or bankruptcy outcomes could have potentially reduced gross returns by 20%. This return reduction can be accommodated within the venture framework, but it requires careful diligence to do so.


Source: ARK Invest, Correlation Ventures; Data are from financings 28k between 2009 to 2018 that resulted in exits or dissolutions. The historical data presented is for illustrative purposes only, does not represent returns of the ARK Venture Fund, and should not be used to form the basis of any investment decision. The total return dynamic illustrated may not continue in the future.

  1. https://www.computerworld.com/article/3687988/bing-vs-google-the-new-ai-driven-search-wars-are-on.html

  2. https://www.latimes.com/business/story/2023-02-03/google-invests-400-million-chatgpt-rival-anthropic#:~:text=Bloomberg%20Feb.%203%2C%202023%203%3A29%20PM%20PT%20Alphabet’s,according%20to%20a%20person%20familiar%20with%20the%20deal

  3. https://abc.xyz/investor/static/pdf/20230203_alphabet_10K.pdf?cache=5ae4398

  4. Venture capital is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which have demonstrated high growth.

  5. https://www.nytimes.com/2023/01/30/technology/stripe-thrive-funding.html

  6. Stripe last raised money in March of 2021 when Adyen’s stock was trading at roughly $23. As of February 13th Adyen trades at $14.50, a rough 40% discount.

  7. A round of financing is funding that a startup receives from private equity investors or venture capitalists. It is normally the second stage of financing after seed capital.

  8. https://fortune.com/2023/01/11/structure-openai-investment-microsoft/

Investors should carefully consider the investment objectives and risks as well as charges and expenses of the ARK Venture Fund before investing. This and other information are contained in the ARK Venture Fund’s prospectus, which may be obtained by visiting www.ark-ventures.com. The prospectus should be read carefully before investing.

To view the top 10 holdings in the ARK Venture Fund, click here. To view the most up to date portfolio, click here.

An investment in the ARK Venture Fund is subject to risks and you can lose money on your investment in the ARK Venture Fund. There can be no assurance that the ARK Venture Fund will achieve its investment objectives. The ARK Venture Fund’s portfolio is more volatile than broad market averages. The ARK Venture Fund also has specific risks, which can be found in the prospectus.

Foreside Fund Services, LLC, distributor.

ARK Investment Management LLC ("ARK Invest") is the investment adviser to the ARK Venture Fund.


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