AI Investment Up 57 Percent As Surge Defies Startup Slump

Investors are pouring money into AI despite the startup slump. The reasoning appears to be that getting in now will deliver significant returns later and that the penalty for missing out far exceeds the costs required to build these companies. 

The risk, as always, is that not every company is going to make it, so picking winners in this market is increasingly challenging - and important. JL

Erin Griffith reports in the New York Times:

The A.I. boom has become the strongest counterpoint to the broader start-up downturn. Investors poured $27.1 billion into A.I. start-ups in the US from April to June, accounting for nearly half of all U.S. start-up funding in that period. In total, U.S. start-ups raised $56 billion, up 57% from a year earlier and the highest three-month haul in two years. Companies spent an average of 22% of their expenses on computing costs in the first three months of the year — more than double the 10% spent by non-A.I. software companies. “No wonder V.C.s are throwing money into these companies.” While A.I. start-ups are growing faster than other start-ups, they clearly need the money.”

For two years, many unprofitable tech start-ups have cut costs, sold themselves or gone out of business. But the ones focused on artificial intelligence have been thriving.

Now the A.I. boom that started in late 2022 has become the strongest counterpoint to the broader start-up downturn.

Investors poured $27.1 billion into A.I. start-ups in the United States from April to June, accounting for nearly half of all U.S. start-up funding in that period, according to PitchBook, which tracks start-ups. In total, U.S. start-ups raised $56 billion, up 57 percent from a year earlier and the highest three-month haul in two years.

A.I. companies are attracting huge rounds of funding reminiscent of 2021, when low interest rates and pandemic growth pushed investors to take risks on tech investments. In May, CoreWeave, a provider of cloud computing services for A.I. companies, raised $1.1 billion, followed by $7.5 billion in debt, valuing it at $19 billion. Scale AI, a provider of data for A.I. companies, raised $1 billion, valuing it at $13.8 billion. And xAI, founded by Elon Musk, raised $6 billion, valuing it at $24 billion.

Such financing rounds have boosted the industry’s overall deal-making by dollar amount and number of deals, said Kyle Stanford, a research analyst at PitchBook.

“It’s not declining anymore,” he said. “The bottom has already fallen out.”

The activity has prompted some venture capital investors to change their message. Last year, Tom Loverro, an investor at IVP, predicted a “mass extinction event” for start-ups and encouraged them to cut costs. Last week, he declared that era over and christened this time the “Great Reawakening,” encouraging companies to “pour gas” on growth, particularly around artificial intelligence.

“The AI train is leaving the station & you need to be on it,” he wrote on X.

The start-up downturn began in early 2022 as many money-losing companies struggled to grow as quickly as they did in the pandemic. Rising interest rates also pushed investors to chase less risky investments. To make up for dwindling funding, start-ups slashed staff and scaled back their ambitions.

Then in late 2022, OpenAI, a San Francisco A.I. lab, kicked off a new boom with the release of its ChatGPT chatbot. Excitement around generative A.I. technology, which can produce text, images and videos, set off a frenzy of start-up creation and funding. “Sam Altman canceled the recession,” joked Siqi Chen, founder of the start-up Runway Financial, referring to OpenAI’s chief executive. Mr. Chen said his company, which makes finance software, was growing faster than it otherwise would have because “A.I. can do the job of 1.5 people.”

Yet even as A.I. creates efficiencies, it is costly to build. Start-ups focused on A.I. need enormous stores of powerful computer chips and cloud storage.

An analysis of 125 A.I. start-ups by Kruze Consulting, an accounting and tax advisory firm, showed that the companies spent an average of 22 percent of their expenses on computing costs in the first three months of the year — more than double the 10 percent spent by non-A.I. software companies in the same period.

“No wonder V.C.s are throwing money into these companies,” said Healy Jones, Kruze’s vice president of financial strategy. While A.I. start-ups are growing faster than other start-ups, he said, “they clearly need the money.”

For investors who back fast-growing start-ups, there is little downside to being wrong about the next big thing, but there is enormous upside in being right. A.I.’s potential has generated deafening hype, with prominent investors and executives predicting that the market for A.I. will be bigger than the markets for the smartphone, the personal computer, social media and the internet. Mr. Stanford of PitchBook said competition from big tech companies including Microsoft and Amazon might also affect A.I start-ups’ ability to raise enormous sums of money. Large deals like the one struck by xAI were outliers and are not likely to be repeated in the second half of the year.

“That can’t happen forever,” he said