• D.C.
  • BXL
  • Lagos
  • Riyadh
  • Beijing
  • SG
  • D.C.
  • BXL
  • Lagos
Semafor Logo
  • Riyadh
  • Beijing
  • SG


OpenAI is raising billions, inviting more regulatory heat for Microsoft

Sep 26, 2024, 11:02pm EDT
tech
Bryan R. Smith/Reuters via pool
PostEmailWhatsapp
Title icon

The Scoop

Prospective new investors in OpenAI, such as Abu Dhabi’s MGX, have privately made clear that investing billions in the startup would require taking an ownership stake in a for-profit version of the company — a move that would also give shares to its largest investor so far, Microsoft, according to people briefed on details of the ongoing negotiations.

The shift will immediately relieve investors, which are looking to put in $6.5 billion in the latest fundraising round, of risks that come with oversight by nonprofit board members, who have little involvement or stake in the day-to-day business of OpenAI.

But the biggest consequences for Microsoft may come from governments. Owning a part of OpenAI could attract more scrutiny from US and European regulators, who are already looking into whether their tie-up is anticompetitive.

AD

Microsoft has been defending itself by arguing that it does not actually own a piece of OpenAI. Instead, it has an agreement to receive profits that are capped, once the company hits a specific multiple of its investments in the company, which total around $13 billion.

OpenAI CEO Sam Altman was in New York this week for the United Nations General Assembly, which he used to urge world leaders to accept the structural change and Microsoft’s ownership stake in OpenAI.

Altman’s pitch to European officials is that his firm can’t raise money without updating its corporate structure, and it needs those funds to continue to improve its technology. And he’s been arguing that OpenAI’s technology is the answer to Europe’s vexing decline in productivity, since its models can be fine-tuned for the region and on local languages, and run on data centers on European soil.

AD

One idea floated in the negotiations with investors is to end the deal that makes Microsoft OpenAI’s exclusive cloud provider, allowing the startup to also use rivals, according to a person familiar with the matter. That could be looked upon favorably by competition regulators in Europe. Ultimately, Microsoft would have to agree to these terms and would likely be compensated for the concession.

Ending the exclusive arrangement might not dampen Microsoft’s fortunes, though. There is a growing realization that the data center capacity needed to train and run future generations of AI models is so large that no single company can provide all of it. And in some ways, Microsoft holds the cards in OpenAI’s fundraising negotiations because it’s first in line to receive OpenAI profits.

Microsoft, OpenAI and MGX declined to comment.

AD

— Liz Hoffman contributed reporting for this article

Title icon

Know More

Long before the upheaval last November that resulted in the brief removal of Altman as the company’s CEO, OpenAI had planned to shift its corporate structure from one controlled by a nonprofit to a more traditional for-profit entity, opting for what’s known as a public benefit corporation.

Unlike other major tech startups, OpenAI did not distribute equity to employees and investors. Instead, it offered them a share of profits. Whereas most companies give employees stock options or restricted stock units, OpenAI distributed equity in the form of “profit participation units,” people familiar with the matter said.

Employees could hold on to their PPUs, or sell them during designated tender offers for a set price. The PPUs are then controlled by an investment entity.

If OpenAI transitions to a for-profit company, its employees are set to receive restricted stock units.

Before the meteoric rise of ChatGPT, OpenAI employees were well compensated but didn’t expect to get wildly rich off of their PPUs. Staffers who have been at the company for years are now able to cash out.

Two people familiar with the matter have said the financial windfall has contributed to the decision of some employees to leave.

The company has lost several high profile employees in recent months, including co-founders Ilya Sutskever and Greg Brockman and Chief Technology Officer Mira Murati, who resigned on Wednesday.

While critics have argued that the departures are a sign of trouble at the company, two people close to OpenAI said it has a deep and growing pool of talent.

Jakub Pachocki, who replaced Sutskever as chief scientist, was already on the rise at the company before Sutskever left, the people said.

And Mark Chen, senior vice president of research at the company, has helped spearhead successful product launches in recent months like GPT 4o. It was Chen who encouraged two researchers at the company to step away from their day-to-day responsibilities to test a theory that ultimately became Strawberry, the code name for a new model that has been praised for its advanced reasoning capabilities.

OpenAI has massively expanded its headcount, from about 375 in January 2023 to 1,700, according to two people familiar with the number.

Title icon

Reed’s view

There are three points that have been largely missed in recent OpenAI news.

First, perhaps the biggest complication in OpenAI transitioning into a for profit is not what some see as turmoil at the company or AI safety concerns. It’s Microsoft and the antitrust scrutiny that would come with it. Microsoft will have to own shares in this new structure and Europe’s competition watchdogs, in addition to regulators in the US, are watching.

If OpenAI is blocked from becoming a for profit company, it won’t be able to raise money, and then it won’t be able to compete in the fast-moving and cutthroat AI landscape.

If that happens, the most likely scenario is that OpenAI’s employees leave, many of them likely joining Microsoft. Essentially, it’s what would have happened if the board coup in November had succeeded.

That result would be a worse outcome from a competition standpoint and does nothing to assuage the fears of AI safety experts.

Second, the narrative that OpenAI is hemorrhaging talent and flailing, fed by Murati’s departure this week, is misguided.

Since November 2022 when ChatGPT was released, OpenAI has completely transformed as a company. It was largely a research organization putting out proof of concept AI demos. It now has billions in revenue and is trying to scale at an unprecedented rate. Companies in that kind of a transition always see churn.

By transitioning to a for-profit and offering workers traditional equity, OpenAI will have a better recruiting and retention pitch for rank and file employees.

Third, Altman getting a stake in the company in the new, for-profit structure is more about investors than it is Altman. Investors don’t trust a CEO who has no financial incentive to succeed. Having no equity might push a company boss to seek other sources of revenue, pulling attention away from the firm and potentially creating conflicts.

And as I reported in March of last year, investors have walked away from OpenAI because of Altman’s lack of skin in the game.

AD