Reflections on the Collapse of Zapata AI

In the arena, trying stuff, some of which did not work.

Towards the end of summer 2024, I had felt that Zapata was starting to see the light at the end of the tunnel. The stock price, after dropping precipitously following the completion of the SPAC merger in March, seemed to be starting to stabilize. Moreover, the pivot from quantum computing to AI seemed to be bearing fruit. In August, Zapata announced a partnership with US Special Operations Command (USSOCOM), and in October, a new defense customer, Mag Aerospace. This was on the heels of a Q2 earnings report showing the highest revenues and highest gross margins to date. In fact, Zapata’s nearly $2 million in Q2 2024 revenue nearly matched that of D-Wave but with less than half the operating expenses.

My optimism was, however, misguided: just 10 days after the Mag Aerospace announcement, Zapata disclosed that it would be ceasing business operations. The closure was a surprise to many people at Zapata, including myself. Despite having worked there for six years, read the financial statements, and been generally interested in risk and uncertainty, it had not occurred to me that Zapata might be about to shutter its doors.¹

In the spirit of a post-mortem, the aim of this post is to share my reflections on why it was that I was caught off guard by Zapata’s collapse.² My inquiry into this revealed that I had missed many subtle but important details related to corporate finance. Mainly, I had not appreciated how financially fragile the company was, nor the market dynamics that could cause the company to abruptly run out of money. In particular, efforts to raise capital as well as the expiration of lock-ups appear to have contributed to a rapid decline in the stock price in Zapata’s last month. This post will also discuss two other unexpected events that may have also played some role: Sabine Hossenfelder’s video criticizing Zapata and the restructuring of Andretti Global.

Zapata’s financial situation in mid-2024 was precarious owing to its short runway. At the end of Q2, Zapata held on $7 million in cash, an amount equal to the Q2 operating loss. Although it had little cash on hand, being a public company gave Zapata a number of options for raising capital.³ In particular, Zapata had a purchase agreement with Lincoln Park Capital, which effectively was a mechanism for selling shares to the public market. Subject to some constraints on timing and volume, it allowed the company to raise capital at its discretion. Zapata successfully used the agreement for some time, for example to raise $5.3 million in Q2.⁴ Such agreements are, however, only useful to the extent that there are interested buyers in the public markets.

One factor that discouraged investors was the company’s liabilities. At the end of Q2 2024, Zapata reported that its liabilities exceeded its assets by $27 million, an amount that was quite large compared to the perceived value of the underlying business. Although there were several components to these liabilities, the Sandia forward purchase agreement is noteworthy as it seems to have been an especially pathological source of fragility.⁵ These financial burdens undoubtedly made the company less attractive to investors. The possibility of insolvency may have also dampened interest in other types of transactions, such as an acquisition of the company or some of its assets or business units. Altogether, the financial considerations meant that Zapata had little breathing room to withstand any unexpected perturbations to the stock price in the second half of 2024.⁶

The timing of changes in market behavior can provide some clues as to why the stock ultimately did end up falling rapidly, declining 45% in September 2024. The chart below shows the trajectory of the stock price in the last couple months before the cessation of business operations was announced. Two days in particular stand out as transitions in market behavior: September 13 and September 30. The afternoon of September 13 sees a jump in volume and the beginning of a sharp downward slide in price: the stock fell 17% in two trading days, and by September 27 had fallen 25% while maintaining this elevated volume. Meanwhile the morning of the September 30 sees an even larger jump in volume as well as a large instantaneous drop in price. The day finishes 23% below the previous trading day’s closing price.

Although the timing of these events can offer us some clues into the reasons for the overall decline in stock price, I should note that I am usually skeptical of any causal analysis of short-term fluctuations in asset prices. It’s hard to know everything that is happening behind the scenes. In addition, markets can exhibit a lot of chaotic behavior owing to the feedback loops between stock price, investor attitudes, news coverage, social media, etc. Nevertheless, I think there are good reasons to suspect that two events in September 2024 may have been the proximal causes of these transitions: the initiation of the second Lincoln Park purchase agreement and the expiration of a lock-up agreement imposed on early investors.

The reason to suspect that the second purchase agreement was behind the September 13 transition is the timing. For context, Zapata’s first purchase agreement with Lincoln Park Capital could only be exercised when the share price was above $0.50. The second agreement lowered the floor to $0.10 and would allow Zapata to continue raising funds. At the end of the trading day on September 12, the SEC approved the second purchase agreement’s preliminary prospectus. On the morning of September 13, the finalized prospectus was accepted by the SEC, represented by the first vertical line in the chart above. The timing of this suggests that a sale of shares to the public market through the new purchase agreement could explain the transition in market behavior in the afternoon of September 13.

Another possible factor, however, was a video from Sabine Hossenfelder criticizing Zapata and a number of other quantum-related companies, which was published at 11 AM Eastern this same day. It painted a picture of Zapata as a quantum computing vaporware pump and dump and focused in particular on a Zapata announcement related to applications of near-term quantum computers for drug discovery as an example of quantum hype. Moreover, the video probably had more reach than almost any other Zapata-related content had achieved: Hossenfelder has over a million followers and the video has been viewed hundreds of thousands of times.

Despite the timing and wide reach of the video, I am nevertheless skeptical that it played a big role in the shift in market dynamics. For example, it would seem odd for the video to trigger such a discrete change in market behavior, and to do so after a delay of several hours. It also didn’t seem to get much attention from retail investors (e.g. on Stocktwits or r/ZPTA) or have much effect on the stocks of other companies it criticized. My view is that the purchase agreement is a more likely explanation for the sudden change in market behavior on September 13, although the video certainly could have contributed to the overall decline in the stock price over the following weeks.

As an aside, I should mention that Hossenfelder’s depiction of Zapata was exceedingly misleading. Although the video arguably never said anything that was technically incorrect, it completely missed that Zapata’s commercial efforts had pivoted to AI, something long recognized by the quantum computing community. Some R&D work on quantum computing did continue, but much of this effort had shifted from near-term applications (such as the drug-discovery work cited by Hossenfelder) to the sober world of error-corrected quantum computing, mainly through DARPA’s Quantum Benchmarking program. Frustratingly, Hossenfelder cherrypicked the content that would make Zapata look the worst and fit into the video’s narrative. (Although, to be fair, I don’t believe that she intended or expected her content to contribute to the company’s demise and will note that she later expressed remorse.)

Regarding the September 30 transition, there are several pieces of evidence implicating the expiration of lock-ups for early investors. This date represented the first trading day after the the lock-up imposed on holders of preferred pre-SPAC Zapata stock expired on Saturday, September 28.⁷ The notion that the lock-up expiration was responsible for the price drop is further supported by filings indicating that four institutions disposed of a large amount of Zapata stock on the 30^th.⁸

However, another factor possibly contributing to the price decline around this time was the revelation of a restructuring of Andretti Global that included a hand over of day-to-day operations from Michael Andretti to Dan Towriss. This revelation was triggered by an article published by Sportico on the morning of Friday, September 27, which (incorrectly) reported that Michael Andretti was exiting his ownership stake in Andretti Global and received a huge amount of attention within the racing world.⁹ Because Michael Andretti was a key personality in the SPAC that took Zapata public, the article also discussed Zapata (and not in the best light). At the time, I had thought that these events where what triggered the decline in stock price that began at the end of September. However, in retrospect, I suspect the Andretti restructuring had a relatively minor effect because there was little movement in price or volume on the 27^th, and the behavior on the 30^th can be explained by the expiration of the lock-up as described above.

Although there is much that could be said about the underlying causes of everything described above and what Zapata could have done differently, I wanted to limit this post to just discussing the proximate causes of the collapse. In part, this is because, whatever Zapata’s flaws were, the universe has already addressed them by destroying it.¹⁰ On top of that, I think it is not so easy to draw any profound conclusions because, as Peter Thiel is fond of saying, failure (at least in the context of business) is overdetermined. I have heard many people reduce Zapata’s failure to some singular root cause, a failure to do some particular thing X. The problem is that even if you did X, you still might have ended up eventually failing anyway because you didn’t do Y and Z.

That said, had Zapata held on for another month or two, it very likely would have been able to greatly extend its runway due to the surge of interest in quantum computing and AI equities towards the end of 2024. Although this wave (at least the quantum part of it) is almost certainly a bubble, it has nevertheless allowed companies like Rigetti, D-Wave, and Quantum Computing, Inc. to raise significant amounts of capital. It probably would have also allowed Zapata, even with the pivot to AI, to do the same. This notion is supported by the fact that in mid-December, Zapata’s stock skyrocketed from a few pennies back to well over 30 cents, which, remarkably, is higher than price just prior to announcing the closure. This is pretty surprising considering that not only had Zapata ceased operations and been delisted, but also had disclosed that shareholders would be unlikely to receive any assets. It seems like investors are motivated at least in part by speculation that shareholders could nevertheless receive a windfall from the liquidation of Zapata’s IP portfolio.

A silver lining to this saga is that many of the relationships born at Zapata live on. A number of Zapatistas have been hired by former Zapata customers Andretti Global and L3Harris. Another group continues working together within the Flagship Pioneering ecosystem. Some ex-Zapata employees have also begun forming new companies together. As is often the case with complex systems, many subsystems outlive their parents. And markets, like nature, leave nothing to waste.

1. Arguably this was my worst forecasting error since the FBoy Island Season 2 finale.

2. Although the views expressed here are my own, I would like to acknowledge the various Zapatistas and other friends who helped me better understand the events of last year.

3. On the flip side, going public can be a very expensive proposition. As I understand it, a significant portion of Zapata’s debt originated from the costs of carrying out the SPAC merger, and a significant portion of the operating expenses went to administrative activities associated with being publicly traded.

4. See page 17 of the 2024 Q2 10-Q.

5. Seeing how quickly Zapata blew up has made me much more wary of the level of debt held by the US Government. Debt is one of those things that is fine until suddenly it isn’t.

6. A decrease in the stock price would, under the terms of the agreement, make things worse for Zapata in two ways. First, Zapata’s liability would increase, in a manner not unlike being the counterparty to a put option. Second, Sandia would gain additional choices for accelerating the payment timeline. On top of that, I would speculate that the convoluted nature of the agreement meant that it was hard for many people at Zapata to fully appreciate the implications of a sudden drop in stock price and react quickly. Note that some sources have portrayed Sandia’s acceleration of the payment timeline as the proximal cause of Zapata’s decision to shut down. However this portrayal seems to be based on a misinterpretation of the filings: the board’s decision to shut down the company was actually made the day before Sandia notified Zapata of it’s intent to accelerate the valuation date.

7. Prelude Ventures, Hudson Bay Capital Management, Walleye Capital, and Glazer Capital all ceased to be beneficial owners of 5% or more of Zapata stock on September 30, 2024.

8. See, for example, page 126 of the September 3, 2024 S-1.

9. An added layer of drama here is that Michael Andretti has something of a rivalry with Roger Penske, whose son created the media company behind Sportico.

10. In contrast, media organizations and commentators such as Sportico and Sabine Hossenfelder have no skin in the game: they don’t bear any costs for their mistakes and will be able to continue making them.