AI's Winning Streak: Crushing the Venture Capital Slump

Despite the ongoing downturn in venture capital investing, generative AI remains a shining beacon of optimism. Crunchbase data shows VC funding down by 53% in Q1 2023 compared to last year. However, generative AI remains a standout sector, having already attracted four times the capital invested throughout 2022 during Q1 2023 alone.

AI: The Next Gold Rush

A mix of massive excitement, external pressures, high operating costs, and lofty goals is driving this surge in generative AI investment. With a multitude of competitors fighting for funding, some venture capitalists are calling this race the next gold rush.

Venture capital investment has been in the doldrums since the Federal Reserve's interest rate hikes in late spring 2022. Tech valuations and multiples spiraled downwards, causing the IPO market and growth equity funding to dry up. This was followed by slowdowns in early and mid-stage funding. Layoffs.fyi reports that technology companies have eliminated over 330,000 positions in 2022 and 2023.

However, generative AI has emerged as a standout sector in this bleak landscape, drawing investor interest with its potential and promise. Notable funding rounds in recent months include:

• OpenAI raising a whopping $10 billion from Microsoft in January

• Anthropic securing back-to-back $300M raises in early 2023 at a valuation of $4.1 billion

• Jasper raking in $125 million in October at a valuation of $1.5 billion

• Stability AI grabbing $101 million at a valuation of $1 billion

• Character.ai collecting $150 million

• Humane pocketing $100 million

OpenAI's staggering $10 billion funding round alone far exceeds the $2.65 billion invested in generative AI companies in 2022, as reported by CB Insights.

The High Cost of AI Development

Creating the next big AI company often requires massive capital for computing resources. Mike Volpi, a partner at Index Ventures, estimates that startups need at least $500 million to develop their own large language model, the technology powering ChatGPT.

Insiders suggest that a huge chunk of OpenAI's recent $10 billion in funding will be allocated to computing power from Microsoft's Azure cloud computing service. Tech publication The Information recently reported that emerging AI entrants are struggling to secure enough computing power for their own AI model development.

Fresh off a $150 million funding round, Character.ai has announced plans to seek additional funding from "strategic partners," potentially including major cloud computing players like Google, Microsoft, or Amazon. Although Character.ai currently doesn't generate revenue, the company is exploring various paid business models.

AI startup Anthropic, which is seeking to develop a foundational model to compete with OpenAI’s ChatGPT, followed a similar path, raising a $300 million funding round led by Google in March 2023. Shortly after, Anthropic announced another $300 million raise led by Spark Capital.

Earlier this month, news publication Semafor reported that Stability AI, a rising star in the generative AI industry, had burned through a "significant chunk" of its $100 million funding round from last fall. This has led to internal turmoil as the company reevaluates its go-to-market strategy, which has generated minimal revenue so far, and prepares for its next funding round.

A Growing Market Meets Growing Skepticism

While Pitchbook estimates the global generative AI market will reach $42.6 billion in 2023, skeptics question whether startups can grab a significant share of this spending. Sam Lessin, a venture capitalist at Slow Ventures, argues that AI advancements don't necessarily translate into opportunities for startups. Instead, Lessin believes investing in the publicly traded stocks of big tech companies is the best way to invest in AI. .

Lessin expressed his skepticism on Twitter, stating, "I am very very very skeptical that the value of generative AI will be captured by startups vs. incumbents.” He further elaborated, “Unlike a real platform shift, AI is just an accelerant to existing businesses and existing patterns of distribution - and is super-duper easy for incumbents to just slot in to what they already do."