AI startups revolutionize coding industry, leading to sky-high valuations

(Corrects paragraph 14 to remove reference to Google and Amazon declining to comment. This line also appeared in an earlier version of this story.)

By Anna Tong and Krystal Hu

SAN FRANCISCO (Reuters) -Two years after the launch of ChatGPT, return on investment in generative AI has been elusive, but one area stands out: software development.

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So-called code generation or “code-gen” startups are commanding sky-high valuations as corporate boardrooms look to use AI to aid, and sometimes to replace, expensive human software engineers.

Cursor, a code generation startup based in San Francisco that can suggest and complete lines of code and write whole sections of code autonomously, raised $900 million at a $10 billion valuation in May from a who’s who list of tech investors, including Thrive Capital, Andreessen Horowitz and Accel.

Windsurf, a Mountain View-based startup behind the popular AI coding tool Codeium, attracted the attention of ChatGPT maker OpenAI, which is now in talks to acquire the company for $3 billion, sources familiar with the matter told Reuters.

Its tool is known for translating plain English commands into code, sometimes called “vibe coding,” which allows people with no knowledge of computer languages to write software. OpenAI and Windsurf declined to comment on the acquisition.

“AI has automated all the repetitive, tedious work,” said Scott Wu, CEO of code gen startup Cognition. “The software engineer’s role has already changed dramatically. It’s not about memorizing esoteric syntax anymore.”

Founders of code-gen startups and their investors believe they are in a land grab situation, with a shrinking window to gain a critical mass of users and establish their AI coding tool as the industry standard.

But because most are built on AI foundation models developed elsewhere, such as OpenAI, Anthropic, or DeepSeek, their costs per query are also growing, and none are yet profitable.

They’re also at risk of being disrupted by Google, Microsoft and OpenAI, which all announced new code-gen products in May, and Anthropic is also working on one as well, two sources familiar with the matter told Reuters.

The rapid growth of these startups is coming despite competing on big tech's home turf. Microsoft’s GitHub Copilot, launched in 2021 and considered code-gen’s dominant player, grew to over $500 million in revenue last year, according to a source familiar with the matter.

Microsoft declined to comment on GitHub Copilot’s revenue. On Microsoft’s earnings call in April, the company said the product has over 15 million users.

LEARN TO CODE?

As AI revolutionizes the industry, many jobs – particularly entry-level coding positions that are more basic and involve repetition – may be eliminated.

Signalfire, a VC firm that tracks tech hiring, found that new hires with less than a year of experience fell 24% in 2024, a drop it attributes to tasks once assigned to entry-level software engineers are now being fulfilled in part with AI.

Google’s CEO also said in April that “well over 30%” of Google’s code is now AI-generated, and Amazon CEO Andy Jassy said last year the company had saved “the equivalent of 4,500 developer-years” by using AI.

In May, Microsoft CEO Satya Nadella said at a conference that approximately 20 to 30% of their code is now AI-generated. The same month, the company announced layoffs of 6,000 workers globally, with over 40% of those being software developers in Microsoft’s home state, Washington.

“We’re focused on creating AI that empowers developers to be more productive, creative, and save time,” a Microsoft spokesperson said. “This means some roles will change with the revolution of AI, but human intelligence remains at the center of the software development life cycle.”

MOUNTING LOSSES

Some “vibe-coding” platforms already boast substantial annualized revenues.

Cursor, with just 60 employees, went from zero to $100 million in recurring revenue by January 2025, less than two years since its launch. Windsurf, founded in 2021, launched its code generation product in November 2024 and is already bringing in $50 million in annualized revenue, according to a source familiar with the company.

But both startups operate with negative gross margins, meaning they spend more than they make, according to four investor sources familiar with their operations.

“The prices people are paying for coding assistants are going to get more expensive,” Quinn Slack, CEO at coding startup Sourcegraph, told Reuters.

Both Cursor and Windsurf are led by recent MIT graduates in their twenties, and exemplify the gold rush era of the AI startup scene. “I haven’t seen people working this hard since the first Internet boom,” said Martin Casado, a general partner at Andreessen Horowitz, an investor in Anysphere, the company behind Cursor.

What’s less clear is whether the dozen or so code-gen companies will be able to hang on to their customers as big tech moves in.

“In many cases, it's less about who's got the best technology — it’s about who is going to make the best use of that technology, and who's going to be able to sell their products better than others,” said Scott Raney, managing director at Redpoint Ventures, whose firm invested in Sourcegraph and Poolside, a software development startup that’s building its own AI foundation model.

CUSTOM AI MODELS

Most of the AI coding startups currently rely on the Claude AI model from Anthropic, which crossed $3 billion in annualized revenue in May in part due to fees paid by code-gen companies.

But some startups are attempting to build their own models. In May, Windsurf announced its first in-house AI models that are optimized for software engineering in a bid to control the user experience. Cursor has also hired a team of researchers to pre-train its own large frontier-level models, which could enable the company to not have to pay foundation model companies so much money, according to two sources familiar with the matter.

Startups looking to train their own AI coding models face an uphill battle as it could easily cost millions to buy or rent the computing capacity needed to train a large language model.

Replit earlier dropped plans to train its own model. Poolside, which has raised more than $600 million to make a coding-specific model, has announced a partnership with Amazon Web Services and is testing with customers, but hasn’t made any product generally available yet.

Another code gen startup Magic Dev, which raised nearly $500 million since 2023, told investors a frontier-level coding model was coming in summer 2024 but hasn’t yet launched a product.

Poolside declined to comment. Magic Dev did not respond to a request for comment.

(Reporting by Anna Tong and Krystal Hu in New York. Editing by Kenneth Li and Michael Learmonth)