Recent reporting describes a phenomenon where AI companies are investing in each other (i.e. startups, peers, or ecosystem partners) in loops — cross-investments, equity swaps, strategic tie-ups that appear circular (A invests in B, B invests in C, C invests in A) or closely networked. The article raises the concern that such deals may inflate valuations artificially, create echo chambers, and unsettle fundamentals.
While some level of cross-investment is normal in tech ecosystems, the frequency and structure of these deals in AI now appear more aggressive—and potentially symptomatic of overexuberance.
Here’s how I’d parse it, assess whether it’s a warning sign, and how to position.
What “Circular Investment” Means & Why It’s Concerning
- Mutual equity stakes / cross holdings: AI firms taking minority stakes in each other without major strategic rationale, sometimes in complex loops.
- “Round‐tripping” capital amplification: Some capital may effectively flow full circle—Limited Partners, VCs, or corporates invest in AI firms, which reinvest in each other, causing inflated upstream valuations.
- Valuation deal dependence: Some valuations may increasingly be propped by internal deals rather than external arms-length customers or end users.
- Risk of valuation disconnects: If deals internal to the AI ecosystem are driving increments in valuation rather than real cash flows, fundamentals may get disconnected from paper valuations.
The article suggests this could be a bubble signal: funding inflation beyond sustainable basis.
Why It Matters: Strategic Consequences & Market Risk
- Valuation fragility
When valuations are propped by internal circular deals rather than external user growth or monetization, the break point is shallow. A shock or pullback in one name may cascade through the network. - Capital misallocation
Funds flowing into circular investments may detract from investing in genuinely productive, external-facing ventures or infrastructure. - Conflicts of interest & governance risk
When firms own stakes in each other, decision incentives may distort — capital may be allocated based on equity relationships rather than project merit or ROI. - Exit risk & liquidity trap
If many investments are interdependent, exit liquidity may be constrained: who buys out who? If valuations correct, the interlinked structure may amplify losses. - Regulatory / disclosure risk
Regulators or auditors might scrutinize such circular injections for conflicts, self-dealing, or capital-raise disclosures. Transparency may become a requirement.
What Differentiates Smart Cross-Investment from Bubble Behavior
To separate signal from noise, here are characteristics I’d look for in cross-investments that seem benign vs worrisome:
| Feature | Good / Strategic | Warning / Bubble-like |
|---|---|---|
| Strategic alignment | Investments enable integration, distribution, technology sharing, or mutual value creation | Equity stakes with no clear strategic justification or overlapping function |
| Third-party customer base | The investee has its own external users / clients, not just inter-AI ecosystem users | Core revenue depends on servicing ecosystem peers only |
| Pro rata / minority stakes | Stakes are minority, no control or governance overreach | Cross control, board seats, large minority stakes locked in |
| Valuation discipline | Investments are priced with normal multiples, external benchmarks, due diligence | Premium valuations inflated beyond trend, circular markups without third-party validation |
| Liquidity potential | Investments have exit paths or external acquirers | Hard to exit because ecosystem is insular |
How to Position in the Face of Circular AI Investments
Given this pattern, here’s how I’d hedge, lean, or tilt exposure:
Defensive / Protective Moves
- Trim exposure to highly interconnected AI names
Especially those known for making multiple equity investments in peers—reduce exposure to names with heavy circular investment footprint. - Demand stronger governance & disclosure in AI investments
In new investments, require more stringent financial transparency, no hidden circular deal clauses, clear separation of operational vs investment arms. - Hold optionality rather than large concentrated bets
Spread exposure across infrastructure, service providers, non-AI play adjacency — avoid overreliance on any single AI firm that might be circularly propped.
Opportunistic / Value Plays
- Platforms & infrastructure not engaged in cross-equity loops
Firms whose value depends on scale, reliability, and external demand, not circular AI deal structures, may offer safer lift. - Audit, compliance, due diligence / valuation firms
As scrutiny increases, firms that help assess valuation integrity, investment quality, deal structuring, forensic audit will be in demand. - Enablers with independent monetization
Middleware, toolchains, data pipelines, model markets that derive value from broad adoption rather than internal AI ecosystem moats. - Contrarian exposure to under-invested AI names
Some AI firms that are shunning cross-investment culture may be undervalued; if capital rotates out of aggressive investors, these may be beneficiaries.
Risk & Bubble Scenarios
- Cascade breakdown scenario
A valuation shock or external negative event leads one AI name to cut valuation. Because it is widely cross-invested, the shock reverberates to multiple firms, causing a downward spiral. - Regulatory tightening or accounting scrutiny
Auditors, regulators, or stock exchanges impose stricter rules on inter-firm equity holdings, revaluation disclosure, self-dealing controls. This could force revaluation or unwind of deals. - Liquidity stress
AI startups that depend on circular investments may face funding gaps if external capital slows. They may be unable to service obligations or find fresh cash. - Investor sentiment reversal
If more investors conclude the circular deals are speculative froth, capital flow may rotate out of “AI hype” into safer sectors, causing broad multiples compression.
What to Watch (Signals / Catalysts)
- Disclosure of new cross-AI equity investments; magnitude, structure, valuation.
- Performance of investee firms: are they generating external revenue, or only absorbing ecosystem capital?
- Audit / valuation restatements in AI firms tied to circular holdings.
- News of regulatory reviews or antitrust / securities investigations into circular transactions.
- Funding environment: when external VC or private capital slows, circular deals often crack first.
- Market reaction in AI / tech indices if one high-profile name stumbles (stress test).
My View
I see this as a warning signal—not necessarily a collapse signal. Cross-investment in an emergent ecosystem is natural, but when it proliferates without strategic grounding, valuation stability weakens. I’d lean moderately cautious on AI firms with heavy circular investment activity, and shift overweight into infrastructure, evaluation/audit, and toolchain firms with more defensible, independent revenue.
