Generative AI startups confront big questions

Illustration: Shoshana Gordon/Axios

Generative AI startups may be getting all the attention and venture checks right now, but the next fund raise may be a tougher road.

Why it matters: The market downturn has been raining on startupland’s parade for the past year, but AI has emerged as a bright spot of excitement for entrepreneurs and investors.

Catch up quick: Last year, the release of a few software tools, such as Open AI’s ChatGPT and Dall-E, quickly captured headlines and internet users’ attention with their impressive abilities to generate text, images and even video from written prompts.

• Since then, a growing number of companies — big and small — have jumped into the hype, either adding similar capabilities to their products, or setting out to build new tech.

By the numbers: In 2021, investors poured $4.8 billion across 262 generative AI deals globally, per new data from Pitchbook.

• In 2022, investors put $4.5 billion into the sector across 269 deals.
• Both years, much of the deals (and dollars) have been in seed and early-stage startups.

The big question: Whether these startups will have enough to show in a year or two, after they’ve burned through millions of dollars and could be back in meetings with venture capitalists.

• According to Amplify Partners general partner Sarah Catanzaro, some of the key questions they'll face include "product-market fit;" meaningful revenue; and loyal customers and users.
• "The [AI] techniques themselves will be commodified," Root Ventures partner Kane Hsieh tells Axios. Thus, his firm is more focused on startups that can successfully apply the technologies to a market or use cases.

Between the lines: Computing power is quickly becoming a top — and ballooning — expense for these companies.

• So it’s no surprise to see some of them turn to big tech companies as investors that can also subsidize these resources.

• This also means that alliances have already formed (think OpenAI-Microsoft, Anthropic-Google, Stability AI-Amazon). It could leave others out of luck if there are clauses preventing investments in competitors.

Yes, but: Some VCs aren’t too worried (yet).

• At the seed stage, the valuations haven't gotten too out of hand, according to NFX general partner James Currier. "A lot of [the AI startups] are raising at $6 million-post, $8 million-post [money valuations]," he tells Axios.
• And this week's news of Character AI's funding hints that some companies may not struggle too much — the 16-month-old startup doesn't have revenue (yet) but is already valued at $1 billion.

The bottom line: It'll certainly be interesting to see what happens in the currently tighter venture investment environment, coupled with expectations that this wave of AI startups will yield true tech advancements.

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