Inside the structure of OpenAI’s looming new investment from Microsoft and VCs (2023)

That would be an enormous investment in a market environment where founders are struggling to get prospective investors to even pick up the phone—and for a company that isn’t profitable and likely won’t be for some time.

Microsoft’s bet on OpenAI appears to be even bigger than was previously known. The documents suggest that, prior to this deal, Microsoft had already poured $3 billion into the company—$2 billion more than has been publicly reported. If the current deal is completed at the figures being discussed, the cap table in the documents states that Microsoft will have contributed a total of $13 billion in capital to OpenAI, underscoring how important it believes the technology behind ChatGPT and DALL-E 2 is to its future.

Documents related to the looming investment paint a highly unusual deal structure that appears to be tilted in Microsoft’s favor. But, owing to OpenAI’s hybrid structure—with a non-profit lab and a capped-profit business arm—and its extensive commercial partnerships with Microsoft, there are countless variables that could affect how things ultimately play out and pay out. Here are a few key takeaways based on our analysis of the documents.

Venture capitalists are investing in OpenAI through a tender offer of employee shares, happening in parallel to Microsoft’s potential investment, as we previously reported. All investors—including Microsoft—have caps on their potential returns. That isn’t to say the potential returns are small: Documents show that should OpenAI’s technology become extraordinarily successful and profitable, Microsoft would be able to make as much as $92 billion from its collective investment, and venture capitalists that participate in the tender offer would be able to garner up to $150 billion. (An OpenAI spokeswoman declined to comment for this story, and a Microsoft spokesman didn’t respond to a request for comment.)

Microsoft will receive preferential treatment when it comes to OpenAI profits. The documents lay out how investors will be reimbursed once OpenAI starts posting a profit. “First close partners” will be reimbursed their principal first (it’s unclear whether “first close partners” refers to OpenAI’s early investors, Khosla Ventures and Reid Hoffman’s foundation, or other subsequent investors in the company). Once that has happened, 75% of OpenAI’s profits will flow directly to Microsoft until the sum that Microsoft invested in OpenAI is reached. Here is a graphical representation of how the economics are structured:

While the terms look like a win-win for Microsoft, it could end up being quite a while before Microsoft, or any of the other investors, see a meaningful return on that investment. Documents show that, as of the end of last year, OpenAI was projecting a loss of more than $508 million for 2022. The company has projected $1 billion in revenue in 2024, as was first reported by Reuters, but it’s unclear what it expects its costs to be in the years ahead. According to the documents, OpenAI expected that its costs in 2022 would total somewhere around $544.5 million.

Will OpenAI need to increase its spending in order to achieve its revenue target in 2024? Or maybe the deal with Microsoft will allow it to stabilize its spending by taking advantage of Microsoft resources, such as cloud computing infrastructure and salespeople? The answers to those questions will help determine when OpenAI might swing to a profit, and consequently when Microsoft would begin to recoup its investment. As for venture investors, an active secondary market for OpenAI shares could help offer liquidity and returns more quickly than OpenAI’s planned profit structure allows.

Of course, an investment in OpenAI is not really a play for short-term profits. A bet on OpenAI is a bet that its generative A.I. technology could override the way everyday people access the internet (Google’s management team is reportedly worried about this possibility); it’s a bet that the OpenAI technology—more so than any generative A.I. technology that may come out of Google, Amazon, or Oracle—could power a universe of high-performing digital assistants that are more effective than humans; and it’s a bet that, just maybe, OpenAI becomes the first company to create computers that can think and learn, which could “be the most important technological development in human history,” according to OpenAI CEO Sam Altman.

David Beisel, co-founder and partner at VC firm NextView Ventures (which is not involved in the OpenAI tender offer), says that OpenAI is a way for venture firms to get in early to “the next potential platform shift.”

“There’s a desire to not just be a part of this company specifically, but the beginning of this broader platform shift,” Beisel says. “When you’re part of it early, and when you’re part of the early successes, the success compounds.”

See you tomorrow,

Jessica Mathews
Twitter: @jessicakmathews
Email: jessica.mathews@fortune.com
Submit a deal for the Term Sheet newsletter here.

Jeremy Kahn contributed to the reporting of this essay, Nicolas Rapp designed the chart, and Jackson Fordyce curated the deals section of today’s newsletter.

VENTURE DEALS

- Carbon Health, an Oakland-based hybrid health care company, raised $100 million in Series D funding from CVS Health Ventures.

- NextPoint Therapeutics, a Cambridge, Mass.-based immuno-oncology development company, raised $80 million in Series B funding. Leaps by Bayer and Sanofi Ventures co-led the round and were joined by Invus, Catalio Capital Management, Sixty Degree Capital, PagodaTree Partners, MPM Capital Management, Binney Street Capital, and NextPoint founder Gordon Freeman.

- Capella Space, a San Francisco-based space tech company, raised an additional $60 million in Series C funding through Thomas Tull’s US Innovation Technology Fund.

- Inbenta, a Dallas-based conversational A.I. platform, raised $40 million in funding led by Tritium Partners.

- Hystar, an Oslo-based hydrogen company, raised $26 million in Series B funding. AP Ventures and Mitsubishi Corporation co-led the round and were joined by Finindus, Nippon Steel Trading, Hillhouse Investment, Trustbridge Partners, SINTEF Ventures, and Firda.

- 40Seas, a Tel Aviv-based fintech platform for cross-border trade financing, raised $11 million in seed funding. Team8 led the round and was joined by ZIM Integrated Shipping Services.

- Vaxess, a Cambridge, Mass.-based vaccine patch developer, raised an additional $10 million in Series B funding. RA Capital, The Engine, and Mission BioCapital invested in the round.

- Seek AI, a New York-based data solutions company, raised $6 million in seed funding. Conviction Partners and Battery Ventures co-led the round and were joined by the former CEO of Snowflake Bob Muglia.

- Howdy, an Austin-based Latin American hybrid workforce company, raised $5 million in Series A extension funding. Obvious Ventures led the round and was joined by Greycroft.

- Baton, a New York-based marketplace for small business acquisitions, raised $2.8 million in pre-seed funding. Giant Ventures led the round and was joined by Bloomberg Beta and other angels.

- Playstream, a Tel Aviv-based gaming content company, raised $2 million in seed funding led by General Catalyst.

PRIVATE EQUITY

- Bregal Sagemount acquired a minority stake in Enhesa, a Brussels-based regulatory and sustainability intelligence provider. As part of the deal, Sagemount will acquire ICG’s minority stake in Enhesa and CGE Partners will retain its majority stake in the company. Financial terms were not disclosed.

- Fort Point Capital recapitalized ROX360, an Eastpoint, Fla.-based marketing platform for vacation rental management customers. Financial terms were not disclosed.

- Micross Components, a portfolio company of Behrman Capital, agreed to acquire the High-Reliability DC-DC converter business of Infineon Technologies, a San Jose-based semiconductor solutions company. Financial terms were not disclosed.

- QHP Capital, the management company for NovaQuest Private Equity, acquired a majority stake in COPILOT Provider Support Services, a Maitland, Fla.-based hub services platform. Financial terms were not disclosed.

- Velvet Care, backed by Abris Capital Partners, acquired Almus, a Słomniki, Poland-based tissue converting business. Financial terms were not disclosed.

OTHER

- LeanTaaS acquired Hospital IQ, a Newton, Mass.-based automation solutions provider for hospitals. A deal values the company at more than $1 billion.

- BioNTech agreed to acquire InstaDeep, a London-based decision-making A.I. platform, in a deal worth as much as £562 million ($684 million).

- Amplify Health acquired AiDA Technologies, a Singapore-based A.I. solutions provider. Financial terms were not disclosed.

- Cerberus Sentinel agreed to acquire RAN Security, a Buenos Aires-based cybersecurity company. Financial terms were not disclosed.

- Mercer Global Advisors acquired Empyrion Wealth Management, a Roseville, Calif.-based wealth management firm. Financial terms were not disclosed.

- Specialty Building Products agreed to acquire Amerhart, a Green Bay, Wis.-based building materials distributor. Financial terms were not disclosed.

- Symeres acquired Oncolines, an Oss, Netherlands-based contract research organization. Financial terms were not disclosed.

IPOS

- Mattress Firm Group, a Houston-based mattress retailer, withdrew its plans for an initial public offering.

PEOPLE

- Angeles Equity Partners, a Santa Monica, Calif.-based investment firm, hired Elizabeth Crowe as vice president, operations for Angeles Operations Group. Formerly, she was with BCG.

- Baird Capital, the Chicago-based investment arm of Baird, promoted Katie Schoen to principal, director of investor relations; Becca Schlagenhauf to principal; and Jubril Ayanbunmi to investment manager.

- Capstreet, a Houston-based private equity firm, promoted Kevin Johnson to partner and Evan Harmon to vice president.

- EnerTech Capital, a Philadelphia and Toronto-based venture capital firm, promoted Gian Vergnetti to partner.

- HCI Equity Partners, a Washington, D.C.-based private equity firm, promoted Nate Novak to principal and Ben Choi, Josh DiBiasi, and Sam Hoehn vice president.

- Levine Leichtman Capital Partners, a Los Angeles-based private equity firm, promoted Wouter Snoeijers to senior managing director, Andrew Alexander, Ethan Caskey, Greg Flaster, Ted Jeon, and Weston Richter to managing director, and Paul Hamilton and Colin McCarthy to director.

- Lexington Partners, a New York-based alternative investment manager, promoted Charles D. Bridgeland, Lutz Fuhrmann, Matthew C. Hodan, John Y.S. Lee, Clark D. Peterson, Taylor T. Robinson, and Craig D. Stevenson to partner.

- Odyssey Investment Partners, a New York and Santa Monica, Calif.-based private equity firm, hired Daniel Tiemann as a managing principal and head of portfolio operation and promoted Bill Schwartz to principal. Formerly, Tiemann was with KPMG.

- Percheron Capital, a San Francisco-based private equity firm, promoted Katie Misch and Terence Kwan to partners.

- Tailwater Capital, a Dallas-based private equity firm, promoted Paul Lee to operating partner and Doug Prieto to CEO of Tailwater E&P.