AI Coding Startups Face Financial Squeeze Amid Rising Costs and Shrinking Margins

AI coding startups are facing mounting pressure from soaring operational costs and razor-thin or even negative gross margins, raising serious questions about their long-term sustainability. Despite rapid growth and strong investor interest, companies like Windsurf are struggling to turn a profit, largely due to the high expenses of running large language models (LLMs). In February, Windsurf was reportedly in talks to raise a new round at a $2.85 billion valuation, doubling its value in just six months. However, that deal fell through. Instead, a proposed $3 billion acquisition by OpenAI emerged in April—only for that deal to collapse. The failure of the acquisition raises a key question: if the company was growing so fast and attracting top-tier investors, why sell at all? Insiders reveal that AI coding tools, including Windsurf, often operate at a loss. One source close to the company described gross margins as “very negative,” meaning the cost to deliver the service exceeds revenue. This stems from the need to use the most advanced, expensive LLMs—such as those from OpenAI and Anthropic—because model providers continuously refine their latest versions for coding tasks like debugging and code generation. The challenge is compounded by fierce competition. Established players like GitHub Copilot and Anysphere’s Cursor dominate the market, while new entrants like Replit, Lovable, and Bolt rely heavily on third-party models. These startups are locked into a cycle where they must pay for increasingly costly AI inference, with little control over pricing or performance. The most viable path to better margins is building in-house models, which would eliminate dependency on external providers. However, this is a massive undertaking, both financially and technically. Windsurf’s CEO, Varun Mohan, ultimately decided against it, citing the prohibitive cost and complexity. Meanwhile, model providers are entering the coding space directly. OpenAI offers Codex, and Anthropic has Claude Code, creating direct competition with the startups that once relied on them as suppliers. For Windsurf, selling the business became a strategic exit to secure value before its reliance on these same providers could erode its position. After the OpenAI deal failed, the founders and key employees left for Google, resulting in a $2.4 billion payout to shareholders. The remaining business was acquired by Cognition. While some criticized the move for leaving hundreds of employees without jobs, insiders say it maximized returns for all stakeholders. Anysphere, maker of Cursor, is in a similar but different position. Despite its rapid growth—reaching $500 million in annual recurring revenue (ARR) by June—it has rejected acquisition offers, including from OpenAI, and is pursuing its own model development. In January, it announced plans to build its own AI model and hired two former Anthropic engineers, though both returned to Anthropic shortly after. Anysphere has also adjusted its pricing, passing on increased costs from using Anthropic’s latest Claude model to its most active users. The change, introduced without clear communication, sparked backlash and led to an apology from CEO Michael Truell. While some, like Google Ventures’ Eric Nordlander, believe inference costs will eventually fall, recent trends suggest otherwise. Some of the newest models now require more compute and time, driving up costs. OpenAI’s introduction of GPT-5 with lower fees compared to Anthropic’s Claude Opus 4.1 may signal a shift, but it remains uncertain. For now, the AI coding sector faces a critical dilemma: build expensive models in-house, risk margin erosion, or remain dependent on providers who are becoming competitors. As these startups grow, their ability to sustain profitability will depend on navigating this high-stakes balancing act.