What Are Circular Deals?

A series of eye-popping agreements negotiated among a small number of players in the artificial intelligence (AI) field is raising concerns about the potential risks of so-called circular deals.

In September, OpenAI, the maker of ChatGPT, reached a deal to receive up to $100 billion in investments from chipmaker Nvidia to build data centers. “The partnership can be considered circular,” writes CPA Brian Colello for investment research firm Morningstar, “as OpenAI will likely buy gear from Nvidia, which will reinvest those profits in OpenAI, which will likely use those funds to buy even more Nvidia gear.”

Then, in early October, OpenAI announced another huge deal with a different chipmaker, Advanced Micro Devices (AMD). In exchange for up to a 10% stake in AMD, OpenAI agreed to purchase AMD’s chips for an undisclosed sum, writes Rob Wile for NBC News. “AMD is selling OpenAI both its chips and itself,” which makes it an “unusual deal,” writes Stephen Council for SFGate.

In such so-called circular deals, “investment money is flowing between companies that also buy from or sell to one another,” according to Council. Circular deals have become common in the AI industry, where a small number of companies are “turning to one another for the vast amounts of capital and computing power needed to drive their breakneck growth,” according to Wile. As he describes: “Nvidia plans to invest in OpenAI, which is buying cloud computing from Oracle, which is buying chips from Nvidia, which has a stake in CoreWeave, which is providing artificial intelligence infrastructure to OpenAI.”

“OpenAI is the many-tentacled octopus in the middle, spinning its achievement of ChatGPT into a blitz of speculative investments,” Council concludes.

Bubble or Sustainable Growth?

Circular deals can resemble “round-tripping,” in which companies agree to buy each other’s goods or invest in each other in order to post inflated revenue—without actually increasing their profits. Such negotiated agreements can raise red flags in the marketplace about the companies’ financial health, and they may also violate regulatory and other laws.

In the AI realm, concerns are mounting that insular growth is contributing to a bubble—“a market not actually supported by real consumer demand,” explains Council—that could burst spectacularly. OpenAI and other top firms in the AI industry will need to “generate huge revenues and profits to pay for all the obligations they are signing up for” while also keeping investors happy, according to OnePoint BFG Wealth Partners Chief Investment Officer Peter Boockvar.

Some of the recent deals, including that between Nvidia and OpenAI, remind investment advisers of those that preceded the burst of the dot-com bubble in 2000, according to NBC News. In a note to clients, Bespoke Investment Group called the Nvidia-OpenAI deal “a troubling signal about how self-referential the entire [AI] space has become,” CNBC reports.

“Anyone scarred by the dot-com bubble bursting is keenly aware of the risks of a circular deal in which firms pass funds back and forth to prop up a business,” writes Colello.

“It’s kind of like having your parents co-sign on your first mortgage,” industry analyst Jay Goldberg said to Bloomberg of the circular arrangements. And short seller Jim Chanos posted on X: “Don’t you think it’s a bit odd that when the narrative is ‘demand for compute is infinite,’ the sellers keep subsidizing the buyers?”

Yet others are less worried about the possibility of a burst AI bubble. “We are keeping an eye on these types of deals, but we’re not yet alarmed by them and think of them as arm’s-length transactions,” writes Colello of Morningstar. The fact that “AI demand is both real and booming” alleviates serious concerns, at least for the time being, he says.

Avoiding the Risks of Circular Deals

Beyond the AI realm, how can business negotiators ensure that they don’t expose themselves and others to the significant risks of circular deals?

First, be sure to seek out deals with a wide variety of partners rather than tying your business’s fortunes to a small circle within your industry. Just as investors reduce risk by diversifying their portfolio, dealmakers can do the same by branching out beyond the most obvious buyers or sellers.

Second, ensure your agreements have real financial value. Try separating investment arrangements from sales negotiations to lessen the possibility that a quid pro quo could drive dealmaking. If the sales part of the negotiation doesn’t make economic sense, that’s a sign that any deal reached could pose significant risk.

Finally, be sure to cover a wide range of issues in your negotiations. The presence of multiple issues can inspire creative brainstorming and beneficial trade-offs that draw on the parties’ differing preferences. This, in turn, could lessen the need for parties to resort to back-and-forth financial favors as a means of getting ahead.

What types of experiences have you had with circular deals?