Investors Market – Maybe, Generative AI Market – Definitely
There has been debate recently over whether the startup world, as a market, is friendlier to investors or founders?
Investor-friendly markets are associated with term sheets underlying deals where investors enjoy certain rights, protections, and preferences. Among these, valuations and liquidity preferences standout as most prevalent, but there are many others. (Consider “supra-pro rata rights”. That’s a doozy.) Founder-friendly term sheets and deals, by contrast, include higher valuations, minimal dilution, zero liquidity preferences, shorter vesting periods for founders’ stock, cash-outs, etc.
A typical method for making deals friendly to long-term founders is to refresh their equity position while augmenting the options pool, thereby diluting founders who cut-and-ran.
At this point in late February 2023 the consensus is that the startup market is in an in-between place—friendly to neither side versus the other.
To wit:
Investors are increasingly bringing in terms which are friendly to themselves—for example, liquidity preferences are now 1x standard and flirting with 2x, and valuations have been tamped-down.
Many investors are chasing pre-seed and later seed rounds—it’s not quite a craze yet, but there’s froth forming on the waves, so to speak.
Larger rounds are happening—especially in Silicon Valley—as successful startups transition to growth companies.
PE firms are also aggressively doing earlier stage deals and curbing valuations, and insisting on more metrics for early stage companies and well defined paths to profitability.
A lot of dry power is still on the sidelines, waiting for the right deals.
Businesses going public through a SPAC merger are realizing large gains while the IPO pipe shows signs of opening. Meanwhile, M+A dealmaking, especially large-scale efforts, is officially in a slump.
The recent generative AI “hype storm,” particularly as it concerns ChatGPT, has resulted in the creation of hundreds of startups. A significant foundation for transformation is being set.
According to CB Insights on Feb. 9, 2023:
It took Instagram and Spotify around 2.5 months and 5 months, respectively, to reach 1M users. OpenAI’s new generative AI-powered chatbot ChatGPT, on the other hand, reached 1M users just 5 days after launching at the end of November 2022. In January 2023, it set another record, reaching 100M monthly active users after 2 months. For comparison, it took TikTok 9 months to hit the same threshold. Its climbing popularity is also reflected by a rapid rise in the volume of Google searches on the topic as well as the number of r/chatgpt subreddit subscribers.
An interesting new outlook has formed in academic and investor circles due to ChatGPT and the generative AI phenomenon: Current and future B2B and B2C SaaS and software startup teams must have some founders with AI technology and business experience and training. It’s possible that entire founding teams in the future will come with AI backgrounds even if the company itself is not an AI platform or tool.
This wave is fundamentally different than other disruptions like the big data and data science waves from the early “20-Teens.” This wave sees founders using cloud-based dev tools like TensorFlow, NLP and NLU services, H20, Apache MxNet, Infosys Nia, and Python, for example, for extended durations. The demand for AI engineering is widespread, persistent, and deeper than what we witnessed in the big data and data science expansions. As a related challenge, the AI dev demand wave involves a much larger audience, including all manner of devops and IT, software developers, cybersecurity and anti-fraud professionals, business users, and data scientists.
The generative AI phenomenon is expected to bring on many more non-technical end-users without AI training, and markets outside the U.S. are responding faster than previous technology waves.
So in sum, regardless as to whether the startup market is investor or founder friendly (and we think it’s likely friendlier to investors at the moment), it is definitely becoming one focused on generative AI.