VCs Dish On Startup Red Flags, AI Resistant Sectors, and How They Choose Where to Place AI Bets

There has been a surge in investments in artificial intelligence this year, leading to some venture capitalists becoming increasingly selective.

In Q1 this year, the top 35 venture capital firms announced 51 AI funding rounds, up from 31 in the same period last year, according to S&P Global Market Intelligence.

At the Ai4 conference in Las Vegas, key figures from Citi Ventures, Pinegrove Capital Partners, Alumni Ventures, Blitzscaling Ventures, and Radical Ventures discussed the evolving AI market and how they’re identifying promising startups.

Here are some of the most important trends from the conference.

We’re still in an “overheated” AI market

Vibhor Rastogi, director, venture investing at Citi Ventures labeled the AI market as “overheated,” driven by the release of ChatGPT in 2022.

Rastogi noted that approximately $20 billion was funneled into gen AI over the past year, with major players like OpenAI raising nearly $13 billion, and $1 billion each in Anthropic and Scale AI. Major tech giants such as Google, Microsoft, Meta, and Amazon also announced $100 billion in AI capital expenditures.

“That is an unprecedented scale of investing in a brand-new technology,” said Rastogi. “Ultimately, a lot of that has to pan out into returns.”

Rastogi noted that revenue stemming from AI remains modest compared to the investments made, with OpenAI reporting $2 billion in revenue and other companies trailing far behind.

Much of this revenue is consumer-based and not enterprise-driven, given the latter’s concerns with costs and data privacy, challenges which, if not addressed, could thwart further AI investment.

“I suspect, in the next couple of quarters, we will see a slowdown in both [capital expenditure] and investment,” said Rastogi.

The financial industry is the least impacted by AI

Chris Yeh, general partner at Blitzscaling Ventures, argued that the financial sector is the least likely to be dramatically transformed by AI.

Yeh’s framework, which assesses language-based data, productivity gains, and industry efficiency, suggests that entrenched inefficiencies in finance are maintained by its established players.

“For that, I don’t look to AI to dramatically transform how the entire financial system works,” he said.

Blitzscaling Ventures has invested in companies like MultiOn (which offers consumer AI agents and APIs to help complete complex tasks) and Global Exchange Goods (an AI transaction platform offering tools for traders and market makers for transactions).

Yeh, however, views the education sector as a prime candidate for AI-driven transformation, particularly in personalizing education and providing widespread tutoring.

Regulatory compliance is an investment opportunity

Contrary to the belief that regulatory compliance is a saturated field, Rastogi sees it as “ripe” for investment. Recognizing the growth potential in 2023, Citi Ventures invested in Quantifind, which aids financial firms in anti-money laundering compliance, and Lexeon, which helps lawyers ensure contractual compliance for companies.

“In both cases, the ROI is very significant,” said Rastogi. “Because you could be saving the teams that are working on anti-money laundering, or legal teams, a lot of time and effort if you use AI properly.”

Startups, don’t compare yourself to existing players

Ray Wu, managing partner of Alumni Ventures, cautions against startups that compare themselves to existing market players.

“People tend to say, ‘I’m just like this [company] or that [company],” said Wu. “That’s fine, but there’s already a great example of that company out there. What makes you stand out?”

Instead, Wu is drawn to startups that emphasize unique product offerings, a strong founding team, and sustainable competitive advantages.

Alumni Ventures has backed companies like Cohere (which makes AI products for enterprise companies) and Influence (a platform that connects influencers, brands and agencies).

Achieving long-term differentiation

Parasvil Patel, a partner at Radical Ventures, cautioned against tech becoming commoditized due to innovations from major tech players.

Patel told ADWEEK that many text-generation companies that approached Radical Ventures lacked sufficient differentiation even before ChatGPT. Radical Ventures steered clear of investing in nearly a dozen similar firms, citing the importance of proprietary data and unique product elements for long-term differentiation.

“The challenge is not just creating text but building products with unique data elements or workflows that provide true value,” Patel said. “Without these, companies may merely offer interfaces for generating text, which is unlikely to sustain long-term differentiation.”