Navigating the Boom: How Investors Are 'AI-ing' Big in India While the startup ecosystem tries to leave the funding winter behind, the AI startups and investors are having a pleasant time

India's startup ecosystem has been witnessing funding winter for a while now. However, the emerging technology segment called artificial intelligence garnered attention and capital during the same period from various venture capitalists and institutional investors worldwide and in India.

While India's funding size in AI dropped from USD 14.7 million in 2022 to USD 7.1 million in 2023, the space continues to go strong having raised USD 10.6 million till May 3.

For 2024, the biggest fundraisers were significantly smaller compared to previous ones. Players such as Perplexity.ai, Myelin Foundry, RapidCanvas, Kore.ai, and Atlan have raised funds in the first half of 2024. The biggest funding was bagged by Bhavish Agarwal's Krutrim worth USD 50 million, granting it a unicorn status in January.

Crunchbase data shows venture funding to AI-related startups increased in Q1 2024 (1 Jan 2024 – 31 March) compared to Q4 2023. So, what makes the AI space a fertile one for investors? How does one identify a potential bet?

Funding brief for Q1 2024

In a wave of AI startup funding activity, PineGap.ai founders Deepak Sharma and Ankit Varmani raised USD 2.5 million in seed funding from US-based investors SVQuad and Inventus Capital. Joining the group, Daakia, a deep tech startup specializing in Enterprise SaaS and Digital Communications, raised INR four crore in seed funding led by Green Apple Enterprises' MD Sasi Kumar Marasu, alongside angel investors. Vodexa Generative AI SaaS, helmed by Anshul Shrivastava and Kumar Saurav, secured USD two million from Unicorn India Ventures and Pentathlon Ventures. Sapience Automate, an AI driver assistance technology startup led by Satyajit Neogi, raised INR 1.75 crore in seed funding. Highperformr, another AI (SaaS) startup, founded by former Freshworks executives garnered USD 3.5 million in seed funding from Venture Highway, Neon, and DeVC. Additionally, Atlan raised USD 105 million from Singapore's sovereign wealth fund GIC along with co-investor Meritech Capital at a valuation of USD 750 million. Meanwhile, Myelin Foundry raised USD four million in its latest equity funding from the venture capital arm of the Small Industries Development Bank of India, SIDBI Venture Capital.

Key factors

AI startups train and deploy large language models (LLMs) with extensive datasets and billions of parameters for various applications, such as natural language processing (NLP) and image creation. Hence, data held by startups are a key factor when deciding. "We invest in opportunities that are enablers of businesses and typically help these businesses maximize the value accretion from the data they have. Therefore having the ability of leveraging AI capabilities to maximise such value propositions is key to our investment thesis," shares Abhishek Prasad, Managing Partner, CSVP Fund.

"We prioritize startups that have an early advantage in terms of proprietary data sources or unique technological capabilities. The competitive landscape and customers are very important for us - are there few players globally, are there too many open source initiatives, who and where are the customers, what is the distribution strategy, etc," concurs Som Pal Choudhury, Co-founder & Partner, Bharat Innovation Fund.

Meanwhile, the founder and core founding members are also taken into factor while evaluating an investment. "Our thesis while investing in AI companies is always anchored on the team. We look for the background of the founders as well as their technical experience and expertise. It is important for the team at the helm to have a deep understanding of how to leverage AI to create a future-ready solution," shares Hemant Mohapatra, Partner, Lightspeed Venture Partners.

For Good Capital, founders who harness AI to unlock value in underserved markets and showcase strong execution ability are key. "Rather than starting with a fixed thesis, we focus on discovering high-potential founders through our extensive networks. By engaging early, we can observe their on-the-ground learning journey and assess their ability to uncover opportunities and adapt. This hands-on, grassroots approach enables us to identify the most promising ventures,' shares Arjun Malhotra, General Partner, Good Capital.

Investment trends

CSVP Fund often looks for companies where commercial validation has been established and there is a proven track record. BIF assesses the defensible moat or unique value proposition of the startups it considers investing in across Deep Science, Hardware tech and Advanced Software. Good Capital looks for models that augment human capital in sectors like education, services, and commerce. Meanwhile, Auxano Capital's investment strategy focuses on advancing consumer-facing technologies that will shape the future. When it comes to betting big on AI, Lightspeed completed over 60 global deals in the last 18 months.

Four AI-powered technologies in India including AI software-as-a-service (SaaS), AI Automated technology, Generative AI, and Deep Technology startups are getting support from big capitalist ventures to develop advanced technologies for the Indian and international markets.

Challenges faced

"Often when investing early in such innovations one needs to be quick at identifying pivots and avenues to enable such capabilities. In our journey we have seen several cycles of maturity emerging in this space and also seen a handful of pivots across our portfolio companies to maximise their potential," shares Prasad. Brijesh Damodaran Nair, Founding Partner, Auxano Capital quips that the ongoing enthusiasm for AI's potential has driven up startup valuations, making it a challenge for investors.

AI exists only if there is access to large data sets. Hence, the regulatory and ethical considerations are an important part of the investment process for any VC. Mohapatra and Lightspeed prioritize compliance with government regulations, with a focus on ensuring robust data protection and privacy measures. "While we recognize the need for regulatory frameworks, we believe the benefits of AI in enabling human potential outweigh the challenges," shares Malhotra.

Tier II and III Cities

Digital penetration in Tier 2 and Tier 3 cities is paving the way for initiatives like Digital India to help scale the digital infrastructure and enable increased access to online learning resources. "Coming from regions tackling different challenges, these startups are expected to bring fresh perspectives, innovative solutions, and a deep understanding of local needs, which can be leveraged to create scalable and impactful technologies. We believe there is a huge potential in tier-1 and 2 cities, waiting to be tapped to usher in inclusive growth," adds Mohapatra. Nair echoes the feeling and shares that they are seeing an increase in AI offerings from tier 2 and 3 cities. "The democratization of AI knowledge and tools, along with remote work trends, has enabled talented teams outside major tech hubs to innovate. We are optimistic about these opportunities and actively scout for promising startups in these regions," the founding partner at Auxano Capital adds.

Malhotra notes that such startups often tackle unique challenges in their local contexts. For Nair, Pune and Hyderabad are emerging as new tech hubs, while Mohapatra has also backed founders from Ahmedabad, Jaipur, and Chandigarh.

The Future Outlook

When talking about the emerging trends in AI, generative AI cannot be overlooked. Generative AI is a form of AI technology that is capable of creating diverse content types, such as text, images, audio, and synthetic data.

Tracxn states that there are 6,339 AI startups in the country, with Nasscom reporting that over 60 startups are working in the GenAI space. According to Future Market Insights, the gen AI market in India is expected to reach USD 13.2 billion. EY estimates that India has the potential to add USD 359 billion to USD 438 billion to its GDP via Gen AI adoption.

On the rapid emergence of Gen AI, Mohapatra shares "What we as investors can do is to back bold, ambitious, and capable founders with our capital, our vast global network and our experience in building global companies, and then go on a journey regardless of challenges and risk of failure." Prasad believes that the foundational models are mature enough to start building enterprise-grade use cases.

"India's role in the AI ecosystem is expected to span applications leveraging proprietary data sources, as well as contributions to AI infrastructure, platforms, and open-source initiatives driven by the vibrant developer community," shares Choudhury. According to Stanford University's annual AI Index report, India ranked fifth in terms of investments received by startups offering artificial intelligence (AI)-based products and services in 2023.

IT industry body Nasscom reports that India's AI market is projected to touch USD 17 billion, growing at an annualized rate of 25-35 per cent by 2027. Azim Premji's PremjiInvest, an Indian family office, announced it would be investing USD 10 billion into artificial intelligence companies. At present, it counts over 100 AI startups in its portfolio. The growth in AI spending in India is the fastest among the eight markets surveyed, including Australia, Indonesia, South Korea, Japan, Korea, Malaysia, Taiwan, Singapore, and India, the Intel and International Data Corporation (IDC) report said. Notably, the Government of India announced a USD 1.2 billion investment in AI projects, including the development of computing infrastructure and the development of large language models.