OpenAI secures freedom to dilute its investors

By Karen Kwok

OpenAI is paying a high price to secure its freedom from Microsoft MSFT. The ChatGPT maker on Tuesday unveiled a sweeping deal to break open its quirky shareholding structure and loosen the tech giant's grip. Microsoft gets an equity stake and a commitment to buy more cloud computing. OpenAI CEO Sam Altman gains the liberty to raise the vast amounts he needs from a wider group of investors.

The long-awaited announcement quietly rewrites one of the most consequential partnerships in tech. After months of drawn-out talks with regulators and Microsoft, OpenAI is adopting a more conventional corporate governance model. Its previous setup, a holdover from its non-profit roots, capped investor returns and limited its ability to attract funds from outsiders like SoftBank.

The newly simplified arrangement gives Microsoft and the non-profit OpenAI Foundation each just over a quarter of the company. Other investors, including current and former employees, will own the rest. The software giant led by Satya Nadella will no longer be OpenAI’s exclusive cloud computing provider. While the software giant retains rights to sell OpenAI’s enterprise tools, it will not control other products like the consumer devices Altman is developing with iPhone designer Jony Ive.

Still, Nadella has extracted some valuable concessions. At OpenAI's most recent valuation of $500 billion, Microsoft's 27% shareholding is worth nearly 10 times the $13.8 billion it has invested in the startup. OpenAI has also promised to spend $250 billion with Microsoft's Azure cloud computing unit. Assume the contract stretches over five years, similar to OpenAI's $300 billion deal with Oracle, and it's worth $50 billion a year - half of Azure’s estimated annual revenue by mid-2026, according to analyst forecasts compiled by Visible Alpha.

Meanwhile, Microsoft will continue to receive 20% of OpenAI’s revenue. Based on sales forecasts published by The Information last month that's equivalent to around $100 billion by 2030, though the two companies say payments "will be made over a longer period of time." The arrangement ends if OpenAI achieves "artificial general intelligence", industry jargon for human-level reasoning, as verified by an external panel.

The payoff for Altman is twofold. First, he can drive down costs by negotiating better rates for cloud services and the graphics chips used in data centres. The real benefit, though, is the liberty to raise the tens of billions of dollars in fresh capital that OpenAI will need to honour its commitments to suppliers like Oracle ORCL and chip giant Nvidia NVDA. Shareholders who decline to shovel more cash into OpenAI's furnace therefore risk dilution. Altman will not receive equity in the restructured company, an OpenAI spokesperson said on Tuesday. For existing investors, freedom could prove painful.

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CONTEXT NEWS

Microsoft and OpenAI on October 28 reached a deal to allow the ChatGPT maker to restructure itself into a public benefit corporation, valuing it at $500 billion and giving it more freedom in its business operations.

Microsoft will hold a 27% stake in OpenAI Group PBC, which will be controlled by the non-profit OpenAI Foundation, which will also hold a 26% shareholding, the companies said. The Redmond, Washington-based firm has invested $13.8 billion in OpenAI.

CEO Sam Altman will not get equity in the restructured company, an OpenAI spokesperson said, in a reversal from discussions last year that he would receive equity. The company has no plans to focus on a potential public offering, the spokesperson said.

Microsoft shares rose 2% to $542 by early afternoon in New York on Oct. 28.