High costs and thin margins threatening AI coding startups

In February, AI coding startup Windsurf was in talks to raise a big new round at a $2.85 billion valuation led by Kleiner Perkins, at double the valuation it hit six months earlier, sources told TechCrunch at the time. That deal didn’t happen, according to a source familiar with the matter. Instead, news broke in April that the startup planned to sell itself to OpenAI for roughly the same valuation: $3 billion. 

While that deal famously fell apart, one bigger question remains: If the startup was growing that fast and attracting VC interest, why would it sell at all? 

Insiders tell TechCrunch that for all the popularity and hype around AI coding assistants, they can actually be massively money-losing businesses. Vibe coders generally, and Windsurf in particular, can have such expensive structures that their gross margins are “very negative,” one person close to Windsurf told TechCrunch. Meaning it cost more to run the product than the startup could charge for it.

This is due to the high costs of using large language models (LLMs), the person explained. AI coding assistants are particularly pressured to always offer the most recent, most advanced, and most expensive LLMs because model makers are particularly fine-tuning their latest models for improvements in coding and related tasks like debugging. 

This is a challenge compounded by fierce competition in the vibe-coding and code-assist market. Rivals include companies that already have huge customer bases like Anysphere’s Cursor and GitHub Copilot.

The most straightforward path to improving margins in this business involves the startups building their own models, thereby eliminating costs of paying suppliers like Anthropic and OpenAI. 

“It’s a very expensive business to run if you’re not going to be in the model game,” said the person.

But that idea comes with its own risks. Windsurf’s co-founder and CEO, Varun Mohan, ultimately decided against the company building its own model — an expensive undertaking, the person said. 

In addition, model makers are already competing directly. Anthropic offers Claude Code and OpenAI offers Codex, for instance.

Selling the business was a strategic move to lock in a high return before it could be undermined by the very companies that supplied its AI, including OpenAI and Anthropic, which were also entering the AI coding market.

Multiple people believe that the same pressure on margins Windsurf faced could be impacting Anysphere, the maker of Cursor, as well as vibe coders like Lovable, Replit, and others. 

“Margins on all of the ‘code gen’ products are either neutral or negative. They’re absolutely abysmal,” said Nicholas Charriere, founder of Mocha, a vibe-coding startup and back-end hosting solution serving small and medium businesses (SMBs). He added that he believes the variable costs for all the startups in the sector are very close, likely within 10% to 15% of one another.

Unlike Windsurf, Anysphere has been growing so fast that it intends to remain an independent company, having already turned down acquisition offers, including, reports say, from OpenAI.

And Anysphere announced in January that it is attempting to build its own model, which could give it more control over its expenses. In July, the startup hired two leaders from Anthropic’s Claude Code team, the Information reported, but two weeks later, these employees returned to work at Anthropic.

In addition to building a model, Anysphere could expect the cost of LLMs to decrease over time.  

“That’s what everyone’s banking on,” said Erik Nordlander, a general partner at Google Ventures. “The inference cost today, that’s the most expensive it’s ever going to be.”

It’s not entirely clear how true that is. Rather than falling as expected, the cost of some of the latest AI models has risen, as they use more time and computational resources to handle complicated, multistep tasks. 

When that will change remains to be seen. On Thursday, for instance, OpenAI introduced a new flagship model, GPT-5, with fees that are significantly less than its competitor, Anthropic’s Claude Opus 4.1. And Anysphere immediately offered this model as a choice for Cursor users.

Anysphere has also recently changed its pricing structure to pass along the increased costs of running Anthropic’s latest Claude model, particularly to its most active users. The move caught some of Cursor customers by surprise, since they didn’t expect additional charges on top of its $20-per-month Pro plan. Anysphere CEO Michael Truell later apologized for unclear communication about the pricing change in a blog post.

This is the rock and the hard place. Although Cursor is one of the most popular AI applications, having reached $500 million in ARR in June, the company’s user base may not be so loyal to the product if another company develops a tool that is superior to Cursor, investors say.

Anysphere didn’t respond to a request for comment.

Given the competitive landscape and the costs, Windsurf’s decision to get out may prove to be understandable. After the OpenAI deal fell through, the founders and key employees left to join Google in a deal that led to a $2.4 billion payout to key shareholders. The remaining business then sold itself to Cognition. 

While many, including prominent VCs, criticized Mohan for leaving approximately 200 employees without roles at Google, a source familiar with the deal insisted the acquisition actually maximized the outcomes for all employees. 

Beyond Cursor, other AI coding tools are also among the fastest growing startups of the LLM generation, like Replit, Lovable, and Bolt, and all of them rely on model makers as well.

Additionally, if this extremely popular business sector, already generating hundreds of millions in revenue or more a year, has difficulty building on top of model makers, what might it mean for other, more nascent industries?