AI Valuations Show VC Bubble

Artificial Intelligence start-ups are attracting billions of dollars in seed money as investors try to position themselves for what some are calling the next Industrial Revolution given the impact Generative AI may have on labor productivity and global gross domestic product growth.

French startup Mistral AI, led by a team of former Meta Platforms Inc. and Google DeepMind researchers, scooped up $113 million in seed funding in June. The same month, Toronto-based Cohere, an AI foundation model company that competes with Microsoft-backed OpenAI, raised $270 million in a funding round from investors including Nvidia, Oracle and Salesforce Ventures.

Hugging Face, an AI model start-up, is planning a new funding round that is expected to value at $4 billion, multiple sources with knowledge of the matter told Forbes. The Series D funding round is expected to raise at least $200 million, two sources said,

“AI represents a profound technology shift,” VC firm Sapphire Ventures’ co-founder and CEO Nino Marakovic said in a statement on July 11. “We believe companies are only beginning to see the benefits of AI and GenAI, specifically. Soon, we expect there to be a massive, AI-driven productivity boom that will benefit workers at every level and create value throughout the global economy.”

$15.7 trillion

AI may contribute as much as $15.7 trillion by 2023 to the global economy as labor productivity improvements drive economic growth, according to a report by PwC. Of this, $6.6 trillion is likely to come from increased productivity and $9.1 trillion is likely to come from consumption-side effects, PWC said.

The greatest economic gains from AI will be in China (26% boost to GDP in 2030) and North America (14.5% boost), equivalent to a total of $10.7 trillion and accounting for almost 70% of the global economic impact, PWC said.

To position itself for the expected boom from AI, Sapphire plans to invest more than $1 billion in AI-related enterprise startups. Sapphire will focus primarily on business-to-business software companies that “make AI easily accessible” by “leveraging data to better predict outcomes,” Marakovic said.

Dot AI bubble

AI startups have performed exceptionally well relative to the broader market — collectively raising $15.5 billion this year, according to PitchBook data. Deal pace has remained steady, and the median post-money valuation for AI firms is up 109.8% from last year, according to TechCrunch.

Stability AI founder and CEO Emad Mostaque has a different outlook about the AI start-up frenzy. He predicted earlier this month that AI will be "the biggest bubble of all time" during a call with UBS analysts.

"I call it the 'dot AI' bubble, and it hasn't even started yet," Mostaque said, referencing the dot-com bubble, also known as the Internet bubble, from the late 1990s and early 2000s.

VC Lags

And despite the growth in funding for AI start-ups, it isn’t reflective of the broader VC market.

Global venture capital funding declined 48% in the first half of 2023 to $173.9 billion. A lack of investor enthusiasm and reduced demand due to significantly higher interest rates caused the steep drop.

“Given continued economic uncertainty and the fallout from recent bank failures, we expect that many start-ups will continue to struggle to seek new capital,” EY said in a report in May. “Investors will likely focus on extending the runway for their existing portfolio companies, and we anticipate that new deals will take even longer to be completed.”

New companies “will continue to emerge in this environment, especially those that are able to leverage game-changing technology like generative artificial intelligence,” EY said.

According to research by Carta, there were only 906 venture investments in the first quarter, ending a streak of 21 consecutive quarters in which deal count had reached at least 1,000. That’s a 35% decline from Q4 2022, the largest quarter-over-quarter dip since at least 2016.

A recent spike in down rounds is due in part to the fact that valuations have continued to decline across most stages of the startup lifecycle, says the report. But it’s also due to the fact that valuations have remained depressed for several consecutive quarters.

Some companies that had delayed new fundraisings in hopes of avoiding a down round are nearing the end of their financial runways and have decided that a lower valuation is a lesser evil than running out of cash.