It’s no surprise that the AI market has skyrocketed in recent years, with venture capital investments in artificial intelligence totaling $332 billion since 2019, per Crunchbase data.
However, as AI booms, exit value in the United States is plummeting. M&A for venture-backed companies totals just $47 billion so far in 2024, down from $148 billion in 2021, Crunchbase data shows. At the same time, the IPO market is at a virtual standstill.
The contrast between a frothy AI market and a drought of traditional exits raises the question: How can AI startups break through the noise and set themselves up for a successful exit? This unique situation also underscores the importance of VC discernment when choosing which AI companies to back.
AI defensibility
As an investor, there are multiple factors that signal an AI startup’s defensibility.
A large total addressable market and a solution to a big pain point are baseline qualifiers that indicate a startup is ready to disrupt an industry with AI.
However, that alone is not enough to guarantee a company will endure the test of time. The startup’s target industry also has to demonstrate the potential for widescale change, with the opportunity for AI to replace inefficient processes that congest critical workflows.
Also paramount? An immediate return on investment that drives a strong propensity for the buyer to pay for the solution and consistently 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-powered functionality can give startups a strategic advantage compared to competitors, and promise the ability to operationalize both topline and bottomline performance. All of these factors should be part of founders’ roadmap for a successful exit strategy.
Rational valuation and round sizes
Markets come and go with a different buzzword du jour to drive up valuations and ultimately reset them.
That’s why it’s critical for founders to focus on the business fundamentals, build a product their end user can’t live without, and surround themselves with the right VCs who appreciate the long, nonlinear journey ahead.
A company’s valuation is but a point in time — it’s not an exit generating liquidity and it’s driven purely by what the market multiples are at that moment in time. Thus, it’s critical to raise right-sized rounds (founders — don’t dilute yourself more than you need to) at a reasonable but not overly maximized headline valuation to allow your startup room to grow into the next round. Down rounds are rough for all parties involved and can be demotivating.
The current AI multiples may or may not last three or five or 10 years from now. Betting on AI market multiple expansion is a true gamble, but betting on business fundamentals and rational company value creation is what drives predictably successful exits.
Priya Saiprasad is a general partner at Touring Capital, a VC firm investing in growth stage AI and software startups. She co-founded the firm after 13 years in venture capital, M&A and enterprise technology. She was most recently a partner at SoftBank Vision Fund, where she led investments into software companies including Pixis, Vendr, Observe.AI, CommerceIQ, Sendoso and Skedulo. Previously, Saiprasad was at Mayfield Fund 1 focused on early-growth investments, and a founding member of M12 (Microsoft’s venture fund), where she led investments in Go1, Workboard, PandaDoc, Element AI (acquired by ServiceNow), and Bonsai (acquired by Microsoft). Prior to that, she was a deal lead in Square’s M&A team leading acquisitions at the intersection of software and machine learning.
Illustration: Dom Guzman
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