Navigating the Gen AI Gold Rush: Strategies for Start-ups and Venture Capitalists

In 2023, there was an overall decline in overall mergers and acquisitions (M&A) landscape. However, investments in generative AI companies grew significantly. Investor interest in GenAI  has been significantly high driven by the potential transformative use cases that GenAI posits. The investment frenzy has been fuelled by the rapid success of chatbots, such as ChatGPT, launched in late 2022. Alongside, the growing industry interest in AI is seen in the skyrocketing mentions of "AI" on S&P 500 companies' earnings calls.

On the other hand, the broader M&A landscape has been dampened owing to the prevailing macroeconomic uncertainties.  

The U.S. has dominated GenAI start-up funding since 2018, attracting a whopping 75% share of investments, amounting to $16 billion. Israel, Germany, France, the UK, and China trailed behind with a combined 15% share. Early-stage GenAI start-ups received the most funding (40%), followed by seed-stage ventures (37%). These trends highlight that investments in new GenAI start-ups might be driving the overall funding landscape.

Furthermore, private equity has become increasingly bullish on GenAI. Investment in this sector more than doubled in 2023, reaching $2 billion compared to the previous year. This momentum continues in 2024, with private equity deals for GenAI startups already exceeding the total for the first quarter of 2023 in just the first two months.

In the recent past, the global GenAI start-up landscape has been witnessing a strong funding momentum.  

Perplexity AI, an AI-powered search start-up, is nearing a funding round that could propel its valuation to around $1 billion, offering it a unicorn status. This marks a significant jump from the company's $520 million valuation just two months ago after its Series B round led by IVP, which included participation from tech giants like Nvidia and investor Jeff Bezos.  

Similarly, AI startup, Cognition Labs is potentially raising at a $2 billion valuation, just weeks after announcing their $21 million raise at $350 million. 

Moonshot AI, a young Chinese artificial intelligence company specialising in large language models (LLMs) that can handle extensive text and data inputs, has reportedly secured over $1Bn in a Series B funding round. This funding could propel Moonshot AI to a staggering $2.5Bn valuation, marking the biggest public funding round ever for a Chinese LLM developer.

These skyrocketing valuations reflect the surging investor confidence in the transformative power of AI, and, in particular, GenAI. Fuelled by this confidence, AI start-ups are securing substantial funding rounds in a race to become GenAI leaders. This intense competition creates an "arms race" that will significantly impact the near future of AI.

The Double-Edged Sword of GenAI Competition

The heightened competition in the GenAI start-up landscape fuels competition, with start-ups constantly striving to develop more sophisticated models and applications. This rapid development cycle bodes well to accelerate the pace at which GenAI capabilities mature.

On the other hand, the frenzy to secure funding can incentivise GenAI start-ups to potentially prioritise short-term gains over long-term considerations, including, for instance, potentially neglecting crucial aspects, such as, fostering responsible AI development, and mitigating potential AI biases.

For investors, the rapidly rising valuations in the GenAI space could limit future returns. Additionally, competition from tech giants seeking strategic partnerships with GenAI developers could further complicate the investment landscape.

So, how can one navigate the AI goldrush?

For new GenAI entrepreneurs, the ongoing AI funding frenzy translates to heightened competition to attract VC attention and secure funding. It is important for new GenAI start-ups to understand the VC approach to funding. Instead of being general purpose, they should focus on strategic differentiation by focusing on a clear niche, and building a strong team that combines technical expertise with a focus on ethical AI development.

“The surging investor confidence and focus on Generative AI is fuelling an ‘arms race’ within the GenAI landscape, with GenAI start-ups competing fiercely for funding. While this rapid development cycle promises to accelerate the pace of GenAI advancements, the potential downside of GenAI startups to prioritise short-term gains over long-term considerations, such as responsible AI development and mitigating potential biases, emerges. To ensure sustainable growth in this transformative field, we advocate for a more balanced approach for both emerging GenAI startups and the Venture Capital firms funding them,” says Prothit Sen, Assistant Professor, Strategy.

Here are some key suggestions depending on the focus and type of Gen AI start-up:

• Sustainable Business Goals
  For core AI developers, the emphasis should lie on prioritising demonstrating cutting-edge R&D over immediate profitability. Metrics such as published research, academic citations, and even patent applications could signify the primary indicators of success. However, Gen AI platform and solution developers need to showcase demonstrable user adoption and competitive differentiation. Given the clearer potential path to commercialisation, such Gen AI start-ups need to ensure they are not just innovative, but also commercially viable.
  
  
• Requisite Skillsets and Expertise
  Depending on the focus area and niche of the Gen AI start-up, the team composition and focus would also vary. For instance, core AI developers require research expertise over those with business acumen.
  
  On the other hand, VCs would prioritise a blend of AI expertise with strong go-to-market skills for platforms and applications. Personnel with experience and expertise in areas such as user interface design, cloud operations, and securing enterprise adoption for prior Machine Learning (ML) innovations becomes crucial. This assures VCs that the team not only possesses a deep understanding of the technology, but also the commercial know-how to translate it into real-world success.
  
  
• Sustained Innovation vs. Solution Refinement
  Building a core AI developer start-up requires a long runway before achieving significant impact.
  
  For start-ups focused on Gen AI solutions, the emphasis would be on ongoing continuous innovation. Start-ups in this space would require to demonstrate an ability to refine their offerings based on customer feedback and evolving market demands. The goal would be to build a sustainable competitive advantage through ongoing refinement. Early signs of success need to translate into robust, exponential growth.

What can VCs do?

Venture Capital firms can play a crucial role in steering Gen AI towards responsible development by promoting transparency in data collection and development processes, supporting start-ups that actively mitigate bias within their models, and advocating for the development of explainable AI that fosters trust between users and the technology. This commitment to responsible innovation can ensure GenAI reaches its full potential for positive societal impact.

Responsible Development

GenAI represents a paradigm shift within the broader AI landscape. While the current VC-fuelled environment fosters rapid innovation, it also presents a challenge for start-ups seeking to differentiate themselves. By focusing on a specific niche, prioritising explainability, and building a strong team with a commitment to responsible development, GenAI start-ups can stand out from the crowd and secure a leading position in this transformative field.