It’s no surprise that the AI market has exploded in recent years, with venture capital investments in artificial intelligence totaling $332 billion since 2019, according to Basic Crunch data.
However, as AI booms, the output value in the US is plummeting. Mergers and acquisitions for venture-backed companies total just $47 billion so far in 2024, compared to $148 billion in 2021, according to Crunchbase data. At the same time, the IPO market is virtually at a standstill.
The contrast between a frothy AI market and the dearth of traditional exits begs the question: how can AI startups stand out and prepare for a successful exit? This unique situation also highlights the importance of venture capitalist discernment when choosing which AI companies to back.
AI Defense
As an investor, several factors indicate the defensibility of an AI startup.
A large total addressable market and a solution to a major problem are basic criteria that indicate a startup is ready to disrupt an industry with AI.
However, this is not enough to guarantee that a business will stand the test of time. The startup’s target industry must also demonstrate the potential for large-scale change, with the potential for AI to replace inefficient processes that clog critical workflows.
Also essential? An immediate return on investment which leads to a strong propensity of the buyer to pay for the solution and to systematically renew it.
Equally important is a startup’s ability to accumulate industry-specific proprietary data and create a flywheel effect over time. More data leads to better results, and better results lead to more usage and money spent on the product, which leads to more data.
AI-driven capabilities can give startups a strategic advantage over competitors and promise the ability to operationalize both superior and inferior performance. All of these factors should be part of the founders’ roadmap to a successful exit strategy.
Rational valuation and round sizes
Markets come and go with a different buzzword to drive up valuations and eventually reset them.
That’s why it’s critical for founders to focus on the fundamentals of the business, create a product their end user can’t live without, and surround themselves with the right venture capitalists who appreciate the long, non-linear journey who is waiting for them.
A company’s valuation is just a point in time: it is not a cash-generating exit and is solely determined by market multiples at that point in time. Thus, it is essential to raise good-sized seed rounds (founders – don’t dilute yourself more than necessary) at a reasonable but not overly maximized overall valuation to allow your startup space to grow to the next round. The final rounds are difficult for all parties involved and can be demotivating.
AI’s current multiples may or may not last three, five, or ten years. Betting on multiple expansion of the AI market is a real gamble, but betting on business fundamentals and rational company value creation is what leads to successful and predictable exits.
Priya Saiprasad is a general partner at Capital of tourism, a venture capital firm that invests in growth-stage AI and software startups. She co-founded the company after 13 years of experience in venture capital, M&A, and enterprise technology. She was most recently a partner at SoftBank Vision Fundwhere she led investments in software companies including Pixis, Seller, Observer.AI, CommerceIQ, Sendoso And Skedulo. Previously, Saiprasad was at Mayfield Fund (footnote)Mayfield Fund is an investor in Crunchbase. They have no say in our editorial process. To find out more, head here.(/footnote) focused on early growth investments and a founding member of M12 (Microsoft‘s venture fund), where she led investments in Go1, Work table, PandaDoc, AI Element (acquired by ServiceNow), And Bonsai (acquired by Microsoft). Before that, she was responsible for a deal in SquareThe M&A team leads acquisitions at the intersection of software and machine learning.
Illustration: Dom Guzman
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