The AI sector has gained significant momentum over the past year. Unlike previous venture trends such as crypto or web3, the AI landscape already included several prominent startups and established players when the market began to heat up. Notably, there have been AI exits, and discussions of potential government regulation are emerging. This adds complexity for both founders and investors, particularly since many were not focused on AI just a year ago.
Entrepreneurs are increasingly entering the AI field, prompting early-stage investors to sift through numerous startups to identify those merely capitalizing on the hype versus those poised for substantial growth. Investors are, much like in other sectors, seeking companies that possess a competitive advantage. With industry giants like Microsoft, Google, and OpenAI actively innovating in the space, investors want to ensure they are backing startups that can withstand the competitive pressure from these larger entities.
Chris Wake, founder and managing partner at Atypical Ventures, shared his perspective, stating that his firm is currently taking a cautious approach to AI investments. He expressed concerns about startups built on existing large language models. “Building on someone else’s model to solve a business problem could lead to a race to the bottom,” Wake cautioned. “You might create an appealing business, but not necessarily a transformative one. For me, that lacks significant interest.”
Startups that rely on established models face the risk of being outperformed by major companies introducing new features. Wake emphasized the importance of addressing real problems. Although this may seem obvious, investors can sometimes become overly enthusiastic during hype cycles, only to discover later that the startup lacks product-market fit when market excitement wanes. “AI is a tool, not every problem is suited for it,” he noted. “It’s crucial to identify the right application for AI rather than simply developing an LLM for a specific use case.”
Brian McCullough, a general partner at Ride Home Fund, is particularly interested in companies that radically reframe workflows instead of merely simplifying existing ones. He prefers to support ventures that create entirely new methods for accomplishing tasks, rather than those that just enhance the use of current tools like spreadsheets.
According to Sarah Guo, founder of VC firm Conviction, startups should aim to provide indispensable solutions that potential customers must have, rather than merely desirable options. She cited her firm’s recent investment in Harvey, a startup offering legal insights powered by OpenAI, as an example of a valuable solution. “Sectors where AI can significantly boost efficiency and transform competition are suddenly becoming intriguing,” Guo remarked.
She highlighted two key traits they seek in AI investments: companies developing industry-specific technologies and targeting markets that lack strong incumbents or existing solutions. Both Wake and Andrea Funsten, a partner at RTP Global, agree that the most attractive AI opportunities lie in niche markets—such as legal—or those rich in proprietary data. “I am increasingly focused on companies that develop highly specialized language models, often leveraging synthetic data,” Funsten explained.
Her team is also on the lookout for experienced founders, regardless of their previous AI background, as these individuals are less likely to overextend themselves with large funding rounds or lofty valuations early on. “We prioritize repeat founders entering the AI landscape because they’ve navigated the typical ups and downs of startup life,” she added. “Having founded a company in the past few years, they are familiar with the volatile nature of the industry.”
However, the landscape is rapidly changing. The evolving AI market, coupled with the possibility of future regulations, could dramatically influence trends. Funsten humorously noted that developments are happening so quickly that her perspective on attractive opportunities might differ by the week's end.
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