OpenAI and its biggest backer, Microsoft (MSFT), are debating how to divide the artificial intelligence startup’s spoils when OpenAI becomes a commercial company, but the equity in these assets remains uncertain. It will be a difficult task to agree on a fair market value.
Legal experts say it all depends on who does the math.
“The problem is there are probably six to 10 ways to value a company,” said Angela Lee, a professor at Columbia Business School. “And depending on who you ask, my guess is that it could be off by a factor of three to five, depending on the model you’re using.”
Deriving an accurate valuation for the startup responsible for ChatGPT is nearly impossible, added Anat Alon Beck, a corporate law professor at Case Western Reserve University.
“Given the inherent uncertainty, we suggest that assessments in this context should be treated as ranges rather than hard numbers,” Aronbeck said.
The Wall Street Journal reported earlier this month that OpenAI and Microsoft hired Wall Street investment banks Goldman Sachs (GS) and Morgan Stanley (MS) after OpenAI closed a $6.6 billion funding round. reported that it had asked for advice on these discussions.
Microsoft CEO Satya Nadella (right) and OpenAI CEO Sam Altman (left) at the OpenAI DevDay event in San Francisco on November 6, 2023. (Justin Sullivan/Getty Images) ·Justin Sullivan via Getty Images
Microsoft is among the investors in the latest funding round, which has poured nearly $14 billion into OpenAI since 2019.
The question is how much stock Microsoft should receive in the new for-profit OpenAI in exchange for that $14 billion. There are other thorny issues that need to be resolved regarding rights to future profits.
The New York Times reports that financial pressures, executive departures and disagreements among employees have taken a toll and the issues are being discussed while ties between the two companies have begun to fade. That’s what it means. According to the Times, OpenAI expects to lose $5 billion this year.
OpenAI’s current implied valuation of $157 billion would put it on par with the market capitalization of some of America’s largest and best-known companies, including Wall Street giant Goldman, which advised OpenAI during negotiations with Microsoft. Dew. Goldman’s valuation is now just over $160 billion.
Goldman Sachs headquarters building in Manhattan. (Spencer Pratt/Getty Images) ·Spencer Pratt via Getty Images
Lee said there is understandable justification for OpenAI’s $157 billion valuation, but critics have rightly argued that the number is off base.
“When we talk about hyper-growth companies like Open AI, we’re talking based on what they’ll be worth five to 10 years from now,” Lee said. “So you don’t have performance. You’re based on potential, which is why it’s so difficult.”
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You can make arguments for or against higher or lower numbers. On the one hand, OpenAI’s high-demand artificial intelligence industry and its impressive pace of growth both justify a boost to the company’s valuation, Lee said.
Meanwhile, the company’s business model does not offer a path to profitability, and it loses about $1 billion a year, he said. Coupled with the market’s slow completion of deals, prices should fall, Lee added.
Aronbeck said “information asymmetries” and legal compliance requirements for transitioning from nonprofit to for-profit organizations also make traditional valuation methods less reliable.
“Organizations’ proprietary models, algorithms, and decision-making processes are not fully transparent to potential investors,” Aronbeck said, which could lead investors to overestimate or underestimate value. said.
Reclassification as a for-profit organization would be another seismic shift for OpenAI, upending the way it was established nearly a decade ago.
It was founded in 2015 as a nonprofit organization under the name OpenAI Inc., honoring its mission to advance humanity rather than profit.
Things got further complicated in 2019 when OpenAI CEO Sam Altman and his team created a for-profit subsidiary to raise outside venture capital (including billions of dollars from Microsoft). .
Although this for-profit subsidiary is technically owned by a holding company owned by OpenAI’s employees and investors, it does not give its largest backer (Microsoft) a board seat, and it does It was organized in such a way that it remained under the control of And they have no voting rights.
The inherent tension between these two parts of the company contributed to a dramatic boardroom clash in 2023. At that time, Altman was fired by the board and reinstated five days later.
In the aftermath, Microsoft took a non-voting observer position on OpenAI’s board, but relinquished that seat this year as both OpenAI and Microsoft came under increased regulatory scrutiny. Ta.
What could make these negotiations even more difficult for OpenAI is that undue compensation to nonprofits could make OpenAI This could potentially expose them to legal challenges.
State attorneys general, particularly in Delaware, where nonprofit organizations are registered, may bring suit against parties who violate their legal requirements.
“One of the questions investment bankers have to ask is how realistic people are about valuations and even negotiations,” she said. “I wonder who will be the voice for the nonprofit because the other side may have an incentive to devalue the nonprofit.”
Beyond that, Zhang Rui said fair market value would typically include a premium for nonprofits to give up future participation and majority control.
Legal experts say Microsoft will need to be prepared for significant ongoing expenses as it moves away from a nonprofit model, as it will require additional funding for evaluation work, regulatory compliance and operational integration.
OpenAI said it aims to become a public benefit corporation (PBC), which requires balancing shareholder interests with broader societal benefits.
“Microsoft’s financial exposure is not limited to the initial investment,” Aronbeck said.
Alexis Keenan is a legal reporter at Yahoo Finance. X Follow Alexis at @alexiskweed.
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