Will Generative AI Continue To Grab Investor Attention? Thanks to ChatGPT and COVID-19, many generative AI startups have popped up and some got funded in the last two years. Will capital inflow into the segment continue?

While the use cases of Generative AI (artificial intelligence) have been expanding for some years, the launch of ChatGPT and GPT-4 has made the segment more exciting than ever. We are witnessing a proliferation of new startups working on innovative solutions using Generative AI. Going forward, experts expect to see its wider adoption across industries, including content, retail, healthcare and finance.

Investments in the AI space have anyway been on the rise. According to Stanford University's annual AI Index report, India ranked fifth in terms of investments received by startups offering AI-based products and services last year.

Does this mean that interest in AI in general and the big ChatGPT disruption will lead to Generative AI startups seeing more capital inflow?

Before we go ahead, for those living in a bubble, Generative AI is a subset of AI that creates new and original content in accordance with the data it is trained on, in the form of text, images, videos, audio, and others. Recent breakthroughs like ChatGPT, DALL-E, and GPT-4 have surprised the world with their accuracy and efficiency.

Funding in generative AI

We are still at the nascent stage and many businesses, startups and traditional companies alike, are exploring these technologies. However, despite that, there seems to be a heightened interest in the segment. For instance, in the end of last year, a community-driven and open-source AI innovator Stability AI raised $101 million in funding, led by Lightspeed Venture Partners, Coatue, and O'Shaughnessy Ventures LLC. Hexo raised $270,000 as pre-seed funding led by Antler India, via the VC firm's Antler India Residency initiative. Many others have grabbed the funding pie.

"Generative AI is still a greenfield. So far, generative AI has focused on replicating human IQ and interface. We are yet to dedicatedly embark on the journey to replicate human EQ. Startups working on building exponential innovation in generative AI will attract a lot of capital," said Chirag Gupta, managing partner, 8X Ventures.

According to a survey by McKinsey in 2022, AI adoption has more than doubled over the past five years and the number of AI capabilities that organizations are using, such as natural-language generation and computer vision, has doubled in the past four years. It also says that global AI investment in AI is a simultaneous incline. According to PitchBook data, roughly $1.7 billion was generated across 46 deals in Q1 2023 in the segment.

"While it's true that the launch of ChatGPT has revolutionized the generative AI space, leading to a surge in new startups, the influx of capital into the sector is a more nuanced issue. Indeed, the expanding range of use cases will attract venture investments," said Anirudh A Damani, director, Artha India Ventures. He, however, feels that investors must exercise caution and not fund every company simply because they include generative AI in their description.

It's also worth noting that despite all its success, ChatGPT continues to burn millions of dollars daily. The process of responding to user queries, known as inference, is what drives the cost of running these models into the millions, says a report. Damani thus feels that 99 per cent of these founding teams may be capitalizing on the sector's buzz but may need more technical expertise, resources, and patience to make generative AI work.

Further, market acceptance is not guaranteed even if a tech team successfully develops a fully functional generative AI solution. "This is because customers must not only adopt the product as part of their workflow but also be willing to pay for it, despite the constant emergence of newer and better solutions. Considering these odds, the appetite for investment in the generative AI space may be significant, but the overall returns from these investments will be limited," he said.

Early or growth-stage, who will gain more attention?

The startups that have now built proprietary, distinctive solutions should find it easier to attract growth capita and newer startups at an early stage will likely struggle to raise funds, say experts. "Indian (and global) startup funding is going through turbulent times. A significant number of VCs are sitting on all-time high dry powder. A lot of startups can't get through the scalability and profitability thresholds set by VCs. Most VCs agree that generative AI will be disruptive, scalable, and profitable," said Gupta.

However, some feel that funding interest in the generative AI space will likely span the entire value chain, as these technology-driven ventures require substantial capital during the development and market acceptance stages. "In addition, early-stage investors will be keen to participate right from the ground floor, as they recognize that valuations may soar beyond the range they find palatable once a product begins to deliver results. However, this isn't to say that growth-stage startups won't also attract funding. As generative AI solutions mature and demonstrate market traction, growth-stage investors will see the potential for scaling up and further expanding the business. Ultimately, the investment landscape for generative AI startups will be driven by each venture's unique value propositions and demonstrated capabilities, with opportunities for funding at various stages of development," said Damani.

Exercising caution, key for investors

While there's no denying the massive potential of the generative AI space, investors must approach the sector with caution and due diligence, warn experts. "Investment firms interested in this field should have a team member with a deep understanding of the technology who can evaluate the work being done by startups. As we've seen with the past AI funding boom, many startups have added AI as an afterthought rather than making it a core business component. To avoid repeating this mistake, investors should take the time to thoroughly assess each opportunity and ensure that generative AI is genuinely central to the startup's value proposition and long-term success," added Damani.

Investing in AI startups also requires more than just following the latest trends. It demands a deep understanding of the potential of AI to transform industries and create long-term business opportunities. "Envisioning the future growth and impact of an AI startup is crucial before making investment decisions. This entails not only understanding the specific use cases being addressed but also gaining insight into the underlying technologies being employed. Investors need to go beyond the surface level and grasp the intricacies of how AI is being utilized by startup. This includes understanding the algorithms, data models, and technical capabilities that form the foundation of the AI solution," said Abhimanyu Bisht, General Partner, CapFort Ventures.

Without a comprehensive understanding of the technology and its potential, investments may be based solely on hype, which, experts say, can be risky in the long run.