Silicon Valley's AI deals are creating zombie startups: 'You hollowed out the organization'

Jeff Wang got a large promotion past month. There were tons of tears, but not the blessed kind.

The 39-year-old was unexpectedly named interim CEO of artificial intelligence coding startup Windsurf. The institution had been successful discussions with OpenAI astir a imaginable acquisition that would person resulted successful a handsome payday for galore employees. But the talks fell isolated and, connected July 11, respective founders and apical researchers alternatively near to articulation Google arsenic portion of a $2.4 cardinal licensing deal.  

As 1 of the highest-ranking executives remaining astatine Windsurf, Wang was elevated to the apical job, astatine slightest for the clip being. His archetypal bid of business, helium told CNBC, was to interruption the quality astatine a tense all-hands gathering astatine the startup's Silicon Valley headquarters.

"It was a very, precise challenging day," Wang said. "People were crying. It was very, precise emotional. I was spending fractional the clip calming down people, due to the fact that they person families and they got nothing."

Windsurf is portion of a increasing harvest of AI startups whose founders and apical researchers person been poached by megacaps similar Meta, Google, Microsoft and Amazon done high-priced endowment grabs that are helping the biggest companies skirt regulatory scrutiny. While the deals often nutrient large payouts for founders and AI leaders, they tin permission investors, different employees and the remaining institution successful limbo.

Samir Kumar, a wide spouse astatine Touring Capital, said that what's near is thing resembling a zombie company.

"There's a large question of what their aboriginal prospects are," Kumar said. "Frankly, you hollowed retired the organization." 

The headline-grabbing woody came successful June, erstwhile Meta rocked the tech manufacture by announcing a $14.3 cardinal investment successful information labeling startup Scale AI. As portion of the agreement, Meta took a 49% involvement successful the company, hired its CEO Alexandr Wang to pb a caller superintelligence laboratory and said it would deepen the enactment it does with Scale.

A period later, Scale cut 200 full-time employees, oregon 14% of its staff. Meta's concern had doubled Scale's valuation from $14 cardinal past year. But that fig lone exists connected paper.

Microsoft utilized a akin playbook successful March 2024, erstwhile it hired Inflection AI's co-founders and different staffers. Amazon has completed 2 specified deals successful the past year, nabbing the founders and apical endowment distant from Adept successful June 2024, and from Covariant 2 months later. Google inked a $2.7 cardinal licensing deal with Character.AI and hired its founders past August.

For Silicon Valley task investors, agelong the lifeblood of risky tech startups, the strategy isn't functioning arsenic intended. Companies that would different beryllium connected the way to a imaginable archetypal nationalist offering oregon lucrative acquisition are getting pulled apart, with the bulk of the currency ending up successful the pockets of the founders and their starring engineers.

"The wealth doesn't travel arsenic straightforwardly arsenic it would successful conscionable a axenic M&A transaction," said Rob Toews, spouse astatine Radical Ventures. 

The Scale woody was the exception arsenic acold arsenic task returns go, arsenic Meta's hefty currency concern resulted successful large gains for aboriginal investors, astir notably Accel.

Scale spokesperson Joe Osborne said the institution is precise overmuch alive.

"Comparing Scale to these companies overlooks large differences successful our gross performance, institution size, and woody structure," Osborne said successful a statement. He said Scale has much than 1,000 employees and generated adjacent to $1 cardinal successful gross past year.

"Meta's concern benefited our investors and employees, kept america independent, and positioned america for semipermanent success," Osborne said.

VCs accidental 1 mode to effort and support founders and aboriginal employees from bailing is done secondary offerings, allowing them to merchantability a portion of their ownership to investors truthful they tin bargain a house, repay indebtedness oregon conscionable fastener successful immoderate gains.

But secondary income can't vie with the kinds of offers coming from deep-pocketed tech companies that are flinging unfastened their wallets to triumph the AI battle. Tech investors and startup employees who spoke to CNBC said it's a inclination that threatens to thwart innovation arsenic founders wantonness their ambitious projects to enactment for the biggest companies successful the world.

"This is not concern arsenic usual," said Tom Chavez, co-founder of the startup workplace Superset. "This is simply a disruption."

It's a infinitesimal that began aft the motorboat successful precocious 2022 of OpenAI's ChatGPT, which ushered successful the generative AI boom. At the time, the tech giants were constricted successful their quality to grow done mergers and acquisitions.

The Federal Trade Commission, past led by Lina Khan, was seeking to artifact a fig of notable tech acquisitions, including Microsoft's $69 cardinal statement to bargain Activision Blizzard (a woody that yet closed) and Nvidia's $40 cardinal bid for Arm (a woody that collapsed). It adjacent tried, unsuccessfully, to halt Meta from completing a overmuch smaller woody — the $400 cardinal acquisition of virtual world workplace Within.

Meanwhile, regulators successful Europe were capable to block Amazon's planned $1.34 cardinal acquisition of iRobot past year, soon aft convincing Adobe to walk away from a $20 cardinal acquisition of Figma. In 2022, the U.K.'s Competition and Markets Authority pressured Meta into selling Giphy, which it had bought for $400 million.

The modulation from the Biden medication and Khan's FTC to a 2nd Trump presidency has led to immoderate regulatory loosening, but antitrust concerns remain.

Tech companies, convinced of their request to bulk up successful AI, person recovered a workaround.

"This is present a caller playbook that companies are going to run," said Matt Murphy, a spouse astatine Menlo Ventures. "If it's not cracked down upon, I don't truly blasted them."

Murphy added that companies are getting much explicit successful saying, "Let's conscionable bargain precisely what we privation and permission the remainder behind." He described the process arsenic "a spot soulless."

Maintaining a number involvement means the acquirer could debar triggering an FTC rule that would necessitate a premerger review.

"They're coming arsenic adjacent arsenic imaginable to conscionable getting nether a bulk involvement of a company," said J.B. Branch, an advocator for user rights astatine nonprofit Public Citizen. "They're doing conscionable astir everything they tin bash without benignant of tripping immoderate alarms."

Regulators aren't wholly successful the dark.

The FTC past twelvemonth opened probes into Microsoft's Inflection deal and Amazon's hiring of Adept employees. An FTC spokesperson declined to remark connected the presumption of ongoing investigations oregon imaginable probes.

At Windsurf, the abrupt departure of co-founders Varun Mohan and Douglas Chen near employees reeling. Wang was among them.

Many staffers astatine the all-hands gathering had been expecting to perceive an announcement astir a woody with OpenAI, and immoderate adjacent started filming the session, Wang said. The companies had been in talks astir a imaginable acquisition since the spring.

Those discussions fell isolated aft Windsurf began pushing for a woody that looked little similar a accepted acquisition and much similar Meta's concern successful Scale, according to a idiosyncratic acquainted with the talks. OpenAI wasn't interested, said the person, who asked not to beryllium named due to the fact that the talks were confidential.

OpenAI's exclusivity play for the imaginable acquisition expired connected May 1, according to different idiosyncratic acquainted with the discussions who besides asked not to beryllium named due to the fact that the talks were confidential. Mounting antitrust concerns implicit Microsoft's relation successful the deal, and debates implicit whether the tech elephantine would person entree to Windsurf's intelligence property, besides stalled the talks, the idiosyncratic said.

Microsoft is simply a large capitalist successful OpenAI and has pumped billions of dollars into the startup.

Wang said helium wasn't told wherefore negotiations with OpenAI had ended.

The Google quality broke connected a Friday. Wang's beingness changed successful a hurry. He said helium spent astir 12 consecutive hours connected the telephone with investors, imaginable buyers and panicked customers. Employees were besides barraged with incoming calls from recruiters, helium said.  

At astir 5 p.m., Wang received emails and substance messages from the squad astatine Cognition, different AI coding startup that's champion known for its software-building cause called Devin. After a 9 p.m. telephone telephone stretched past midnight, Windsurf's aboriginal began to instrumentality shape. 

The pursuing Monday, Cognition announced it was buying Windsurf's intelligence property, product, trademark, marque and talent.

Terms weren't disclosed, but according to TechCrunch, the terms was $250 million, oregon little than 10% the magnitude that OpenAI was reportedly successful talks to pay.

"There's decidedly much information present to triumph than before," Wang said. "You conscionable got abandoned, present it's clip to beryllium to the satellite that you're inactive here."

Three weeks aft Cognition's announced purchase, that company's CEO, Scott Wu, had much quality to share. His startup was offering buyouts to Windsurf staffers who weren't sold connected their caller employer.

"Cognition has an utmost show culture, and we're upfront astir this successful hiring truthful determination are nary surprises later," Wu wrote successful a post connected X.

Windsurf employees who chose to judge the buyout would person an further 9 months of wage and wellness care, Wang said. Some underperforming employees were fto go, but would person the aforesaid benefits, helium added. 

"You cannot conscionable person employees that came to effort to thrust a rocket ship," Wang said. "You benignant of request everybody to beryllium each in."

For now, Windsurf volition proceed to beryllium separately wrong Cognition, but Wang said helium doesn't cognize what his occupation volition beryllium successful the aboriginal arsenic the teams integrate much deeply.

"We're some CEOs of each entity," helium said. "I'm really not definite erstwhile the entities combine, what the relation is going to be."

That benignant of uncertainty isn't unsocial to Windsurf.

When Google inked its woody with Character.AI, the hunt giant's large triumph was its hiring of co-founders Noam Shazeer and Daniel De Freitas, who had worked astatine Google successful the past.

At Character, Shazeer and De Freitas wanted to bash 2 things astatine once: physique a foundational AI laboratory and an AI user company. A erstwhile Character employee, who was astatine the institution erstwhile the woody took place, said helium thought the statement could beryllium beneficial to the startup, due to the fact that it would let the institution to absorption solely connected the user business.  

But galore Character employees were drawn to the institution due to the fact that of the founders. Within a period of their exit, up to 10% of the remaining workforce departed, said the erstwhile employee, who asked not to beryllium named due to the fact that the details were confidential.

Dominic Perella, Character's ineligible main who served arsenic the company's interim CEO aft the Google deal, said his institution is acold from gutted. Besides Shazeer and De Freitas, lone a mates twelve researchers left, oregon astir 25% of the company, with 70 employees inactive remaining, Perella said.

Perella added that the full merchandise squad is inactive connected board, arsenic the institution focuses connected shipping caller features to users alternatively than grooming AI models. Consumers usage the app to make virtual characters, including for companionship, paying monthly subscriptions on the way.

Character said it present has astir 20 cardinal monthly progressive users, and that, arsenic of June, paid subscribers were up 250% from a twelvemonth earlier.

"That's rather antithetic from what you deliberation of erstwhile you deliberation of an acquihire," Perella said.

Perella besides said the institution acceptable up an escrow relationship with immoderate of the currency from Google, and volition administer those funds to employees done July of adjacent year, giving them immoderate liquidity from the deal. And, helium said, investors and staffers inactive person the accidental to profit.

"The institution didn't permission investors oregon employees precocious and dry," helium said.

In June, 10 months aft the woody was announced, Character named erstwhile Meta enforcement Karandeep Anand arsenic CEO. Anand had been serving arsenic an advisor to the institution since the anterior summer.

Anand said helium views his relation arsenic helping Character go the societal user app of the AI era, comparing it to what Instagram did for mobile and YouTube for the web.

"A laminitis CEO versus idiosyncratic who comes in, who takes attraction of the institution – that's my job," Anand told CNBC successful an interview. "To beryllium that I tin bash this amended than anyone else."

A Google spokesperson said successful a connection that the institution doesn't hold with the characterization that Character oregon Windsurf are zombie companies.

Inflection employees learned astir their company's woody with Microsoft astatine a last-minute all-hands gathering successful March 2024. Inflection co-founder and CEO Mustafa Suleyman sent a Slack connection instructing staffers to stitchery astatine a edifice successful Mountain View, California, aboriginal the adjacent morning, according to a erstwhile employee. 

That's wherever Suleyman, who antecedently co-founded the AI probe laboratory DeepMind, announced the transaction. Microsoft CEO Satya Nadella besides made an quality to reply employees' questions, said the person, who asked not to beryllium named owed to the backstage quality of the discussions. 

Most of Inflection's existing employees moved to Microsoft, the idiosyncratic said. But Inflection continued to run arsenic a stand-alone company, bringing connected a caller CEO and staff.

Microsoft reportedly paid Inflection astir $650 million, according to reports from The Information and Reuters. That superior was utilized to assistance wage the startup's investors and licence its exertion successful a nonexclusive capacity.

The anterior year, Inflection was valued astatine $4 cardinal successful a $1.3 cardinal concern that included superior from Microsoft and Inflection co-founder Reid Hoffman, a Microsoft committee member.

Still, Hoffman said aft the merchantability to Microsoft that the woody was affirmative for "everyone progressive successful Inflection AI." Hoffman is besides a spouse astatine task superior steadfast Greylock, which was an aboriginal capitalist successful Inflection. 

"This statement with Microsoft means that each of Inflection's investors volition person a bully result today, and I expect bully aboriginal upside," Hoffman wrote successful a post connected LinkedIn.

In March, Inflection named longtime tech enforcement Sean White arsenic CEO. Since losing Suleyman and astir of its unit to Microsoft, the institution has hired 50 employees and is present focused connected gathering endeavor AI products, according to its website, which says its archetypal offering called Pi is an "empathetic and conversational chatbot."

Microsoft and Inflection declined to comment.

Covariant, founded successful Berkeley, California, developed AI systems for warehouse robots. Launched successful 2020, its backers included starring AI researcher Fei-Fei Li, Meta main AI scientist, Yann LeCun, and AI pioneer Geoffrey Hinton.    

The startup had besides signed up astir a twelve customers anxious to usage its software, including a sportswear elephantine and 1 of the starring repast kit companies, according to a idiosyncratic acquainted with the substance who asked not to beryllium named successful bid to sermon backstage information.

On a Friday day past August, everything changed. Some of Covariant's employees were asked to articulation an exigency municipality hallway gathering wherever executives tearfully announced that 3 of the company's co-founders and astir 25% of its astir 120 workers were joining Amazon. As portion of the agreement, Amazon bought a nonexclusive licence for Covariant's halfway technology.

Everyone connected the telephone was told they would not beryllium moving to Amazon, according to 3 erstwhile employees, who requested anonymity to talk freely astir the matter.

Those who were joining included co-founder Pieter Abbeel, who was tapped to assistance pb Amazon's precocious created precocious AI laboratory successful San Francisco. The different 2 co-founders, Peter Chen and Rocky Duan, would beryllium enactment to enactment astatine Amazon building instauration models for the company's much than 1 cardinal robots successful its warehouses.

Remaining staffers were offered acold little charismatic options. They could either permission Covariant instantly oregon enactment connected for astir a period and a half, astatine which constituent they'd beryllium capable to person a severance payment, the erstwhile employees said. 

A "skeleton crew" of astir 10% to 15% of Covariant's workforce is inactive there, 1 ex-employee said, calling it a shade company. Covariant hasn't published immoderate concern updates to its tract since the Amazon woody was announced past year.

While Covariant's founders walked distant with important payouts, rank-and-file employees were near with acold little than they expected to gain erstwhile they joined, the erstwhile employees added.

In a whistleblower ailment filed successful January with the FTC, Department of Justice and Securities and Exchange Commission, a erstwhile Covariant worker claimed that the transaction was "deliberately and unlawfully structured" by Amazon to dodge antitrust scrutiny.

The institution had reportedly been valued astatine $625 cardinal successful a 2023 backing round. Amazon spent much than $400 cardinal to licence Covariant's exertion and bring connected elder method endowment astatine the company, according to the whistleblower complaint, which was viewed by CNBC. That fig includes a last $20 cardinal licensing payment, acceptable to beryllium paid retired 1 twelvemonth aft the woody date, which requires "zombie Covariant staying connected beingness support" until that point, the ailment said.

The transaction presumption handicapped Covariant's quality to question retired aboriginal deals, according to the complaint, which was antecedently reported connected by The Washington Post.

Ted Stinson, Covariant's existent CEO and operating main astatine the time, said the institution had a "decent shot" astatine landing 1 oregon 2 licensing deals with its remaining technology, according to a transcript of a recorded speech cited successful the complaint.

"But they'll beryllium single-digit millions, possibly double-digit millions," Stinson said. "I mean they'll beryllium a fraction of what Amazon paid is my champion guess."

Stinson didn't respond to a petition for comment.

John Tye, an lawyer for the erstwhile worker and a erstwhile State Department whistleblower, said the Covariant woody and different transactions similar it merit stronger authorities scrutiny.

"It's not conscionable a technical, ineligible matter," Tye said successful an interview. "It affects consumers who usage these products. Monopolies are not typically bully for the American public."

Similar to Covariant, San Francisco startup Adept has provided fewer updates connected its enactment gathering agentic bundle since its co-founders and overmuch of its probe endowment were hired distant by Amazon. Less than a twelvemonth aft taking implicit arsenic CEO of Adept, Zach Brock near for OpenAI, and respective employees, including the erstwhile merchandise head, person departed for competitors similar Anthropic.

Covariant and Adept didn't respond to CNBC's requests for comment.

Amazon spokesperson Alexandra Miller said Covariant and Adept proceed to service customers independently. She said that due to the fact that Amazon's licensing woody with Covariant isn't exclusive, "Covariant is escaped to licence its exertion to different companies."

Update: This communicative has been updated to bespeak a much circumstantial gross fig for Scale AI.

— CNBC's Jordan Novet contributed to this report.

WATCH: Meta approached Perplexity earlier monolithic Scale AI deal