Mounting Investor Concerns Over Artificial Intelligence

After years of easy money, the AI industry is facing a reckoning.

A new report from Stanford’s Institute for Human-Centered Artificial Intelligence (HAI), which studies AI trends, found that global investment in AI fell for the second year in a row in 2023.

Both private investment — that is, investments in startups from VCs — and corporate investment — mergers and acquisitions — in the AI industry were on the downswing in 2023 versus the year prior, according to the report, which cites data from market intelligence firm Quid.

AI-related mergers and acquisitions fell from $117.16 billion in 2022 to $80.61 billion in 2023, down 31.2%; private investment dipped from $103.4 billion to $95.99 billion. Factoring in minority stake deals and public offerings, total investment in AI dropped to $189.2 billion last year, a 20% decline compared to 2022.

AI ventures such as Anthropic’s latest multibillion-dollar investment by Amazon, and Microsoft’s $650 million acquisition of top talent from Inflection AI (excluding the firm itself) continue to secure significant funding. The number of AI firms receiving investment is surging, with 2023 seeing 1,812 AI startups declaring investments, a growth of 40.6% compared to 2022 based on the Stanford HAI report.

So, what’s transpiring?

As the biggest players like Anthropic and OpenAI establish their territories, John-David Lovelock, a Gartner analyst, sees AI investment “spreading.” Lovelock told TechCrunch, “The slew of billion-dollar investments has decelerated and is practically finished. The creation of large AI models necessitates substantial funding. The market is currently more affected by the tech corporations that will use existing AI products and services to launch new ones.”

Umesh Padval, who holds the position of managing director at Thomvest Ventures, associates the reduction in overall AI investment with growth rates that did not meet expectations. According to him, the initial surge of excitement has given way to the reality that AI faces a series of challenges, some of them technical and some related to the go-to-market strategy, which will require years to fully address and overcome.

“The slowdown in AI investing is representative of the acceptance that we’re still in the early stages of the AI evolution and its practical application across different sectors,” Padval stated. “Despite the fact the long-term market potential is huge, the initial excitement has been dampened by the difficulties associated with scaling AI technologies in real-life applications … This points towards a more discerning and mature investment environment.”

There could, however, be other factors in play.

Seth Rosenberg, a partner at Greylock, argues that there’s less willingness to fund “a number of new actors” in the AI sector.

“We saw a lot of investment in foundation models during the early part of this cycle, which are very capital intensive,” he said. “Capital required for AI applications and agents is lower than other parts of the stack, which may be why funding on an absolute dollar basis is down.”

Aaron Fleishman, a partner at Tola Capital, says that investors might be coming to the realization that they’ve been too reliant on “projected exponential growth” to justify AI startups’ sky-high valuations. To give one example, AI company Stability AI, which was valued at over $1 billion in late 2022, reportedly brought in just $11 million in revenue in 2023 while spending $153 million on operating expenses.

“The performance trajectories of companies like Stability AI might hint at challenges looming ahead,” Fleishman said. “There’s been a more deliberate approach by investors in evaluating AI investments compared to a year ago. The rapid rise and fall of certain marquee name startups in AI over the past year has illustrated the need for investors to refine and sharpen their view and understanding of the AI value chain and defensibility within the stack.”

“Deliberate” seems to be the name of the game now, indeed.

As stated in a PitchBook report put together for TechCrunch, AI startups worldwide received a whopping $25.87 billion in investment from VCs in the first quarter of 2024. This is an increase from the $21.69 billion invested in Q1 2023. However, the total amount of deals for Q1 2024 fell to 1,545, in comparison to 1,909 for the same period in the previous year. The rate of mergers and acquisitions also saw a decline, with 176 in Q1 2024 compared to 195 in Q1 2023.

Despite the overall decline in enthusiasm among AI investors, there is one area which continues to flourish – generative AI. This involves the creation of new content such as text, images, music, and videos.

According to the Stanford HAI report, investment in generative AI startups hit $25.2 billion in 2023. This is almost nine times the investment seen in 2022 and approximately 30 times the amount invested in 2019. Not only that, but generative AI made up over 25% of all AI-related investments in 2023.

However, Samir Kumar, the co-founder of Touring Capital, isn’t convinced that this boom will continue. He said, “We’ll soon be evaluating whether generative AI delivers the promised efficiency gains at scale and drives top-line growth through AI-integrated products and services. If these anticipated milestones aren’t met and we remain primarily in an experimental phase, revenues from ‘experimental run rates’ might not transition into sustainable annual recurring revenue.”

Kumar has noted that several prominent VCs, such as Meritech Capital, a company with investments in Facebook and Salesforce, TCV, General Atlantic, and Blackstone, have avoided investing in generative AI to this point. Moreover, corporations, which make up the largest customer base for generative AI, are growing more doubtful about the technology’s claims, and whether it can fulfill these.

In two recent survey studies conducted by Boston Consulting Group, approximately half of the respondents, composed entirely of C-suite executives, expressed their disbelief in generative AI’s ability to significantly enhance productivity. They also voiced concerns over the potential for mistakes and data breaches resulting from the usage of tools powered by generative AI.

However, whether this skepticism and the ensuing financial downturns are detrimental depends on individual perspectives.

From Padval’s viewpoint, he considers this a necessary adjustment to the “overzealous investor enthusiasm” within the AI sector. Additionally, he remains optimistic about the future.

“We’re moving to a more sustainable and normalized pace in 2024,” he said. “We anticipate this stable investment rhythm to persist throughout the remainder of this year … While there may be periodic adjustments in investment pace, the overall trajectory for AI investment remains robust and poised for sustained growth.”

We shall see.

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