The world of fundraising and startups is always exhilarating. We’re talking about existential battles for organizations that will define our future. No exaggeration…
With that as the baseline, the past few months have been particularly strange from my POV. Because of shocks to the system in the form of multiple cryptocurrency crashes and the death of Silicon Valley Bank, the fundraising journey has been even more nerve-racking than usual. However, there’s a type of founder who’s been relatively shielded from that heightened anxiety. Amidst the chaos of 2022, founders building AI startups remain unphased. As I discussed with Ellie Wheeler from Greycroft during our fireside chat in April, it seemed like AI startups were stuck in a time warp, still thriving as if they were in the bull market times of 2021. Some might even call it… a bubble.
When anyone refers to a market as a bubble, they imply that prices have become detached from the underlying value of assets. The most referenced historical example is the infamous Dutch Tulip Mania of the 17th century. People became irrationally exuberant, investing exorbitant amounts into tulip bulbs (the equivalent of millions in today’s dollars), only to witness their value plummet within a short span of time.
This might seem crazy as in “who the f is buying tulips for millions” until you consider …
Yes… history repeats itself. Bubbles are a thing.
Observing the flood of AI startups that appeared to emerge overnight (and get funded), I couldn't help but question whether we were witnessing yet another bubble. How could these companies differentiate themselves and maintain a competitive edge when it seemed they threw their products together over a single weekend? There is real change happening for sure… but who would win? How do VCs bet on that… and more importantly for us - how do founders raise capital based on that?!
To go deeper into these concerns, I went to find people far smarter than I to help wade through what we were seeing.
As I stress to founders, your network is one of your biggest assets. In this effort, mine came through and I was able to get Yohei Nakajima from Untapped Capital and Sarah Catanzaro, a GP at Amplify Partners as guests for my event RU VCB: AI Edition (Are You VC Backable?).
In AI circles, Yohei is best known for creating BabyAGI which initiated the trend of basic AGI products and sharing his knowledge while building in public. Sarah comes from an extensive academic background in AI from prestigious institutions like Stanford and MIT as well as practical experience in applying AI to national defense. The two together made for an incredible discussion and open Q&A.
To make this essay match the topic, I used different forms of AI to help summarize the transcript of our fireside to more readable prose. I added a few personal touches, but most of the writing below is AI :) If you’d like to watch the full event, we published the recording here.
During our chat, Sarah, Yohei, and I uncovered deep wisdom about investing in AI. We tackled burning questions that had been on my mind:
As the conversation progressed, Yohei and Sarah brought their extensive insights of the AI domain and their investor experience to the table.
One part of our conversation that unlocked deeper understanding was the discussion about the role AI plays in a startup’s true competitive advantage.
Sarah cautioned against solely relying on AI as a competitive advantage. She highlighted that if AI is the primary source of differentiation for a company, it is essential to have full control over the technology rather than building upon commercial APIs. By having complete autonomy over the technology driving their business, companies can establish a unique value proposition that sets them apart from competitors. This category of differentiation is not where most of the different startups who have sprung up and gotten funded recently fall however. That category of startup which uses OpenAI to create a new experience is different.
For the style of startup, Yohei expressed an optimistic outlook even while acknowledging the perhaps over enthusiastic (bubbly even??) surge in AI-related ventures and the drunken excitement among investors. According to Yohei, the increasing number of AI-focused startups is a result of the availability of solvable problems and the potential for profitable solutions. For him, the equation is straightforward: If there are problems to be solved, and founders are tackling those problems, there is value in investing in their endeavors.
The key for me?
The focus on problem solving is independent of a startup’s use of AI.
The way Yohei described it is if a problem has been identified, and a solution can be developed without the need for AI, founders don’t need to force the the technology into their business. He underlined the importance of understanding the opportunities and potential profitability that exist without AI. However, he also acknowledged the need for entrepreneurs to be well-versed in AI-related topics because investors, especially in this market, will often ask about it. Founders need to have a well-thought-out response to why AI was or was not integrated into the business model. If AI is the right tool to be used to improve your business, you better have a reason for not using it!
At one point in our conversation, I mentioned it was annoying to see startups jam AI into their pitches and asked both Sarah and Yohei what their thoughts were. Did they throw up at that too?
Sarah presented a more open perspective on the matter. She said although inserting AI into a company solely for the sake of appearances may not be ideal, there can be benefits. The reality is that mentioning a company utilizes AI can open doors and generate initial interest from investors. (That is an important first step in raising capital of course).
However, she stressed the importance of clearly articulating another primary source of competitive advantage. In these cases, Sarah said that the main value AI provides these startups is an assist in getting to a real competitive advantage, more likely on the sales and marketing side of things.
The conversation with Yohei and Sarah highlighted the many considerations surrounding AI startups in the VC landscape.
The most important takeaway for me was thinking about AI as a tool to help solve problems for customers. It will NOT be the edge that wins the day but it could help get you there. I believe the same way tech startups in 2000 leveraged the internet to drive tremendous value but not to capture lasting differentiation is the same way startups should think about AI today. AI is a tool that early adopters can use to lead to defensible moats; it should not be the centerpiece of their company or fundraising strategy.