Venture Capital and Generative AI: What The Future Holds

• April 29, 2023

• Minh Trinh

According to a Union Bank of Switzerland study, in January 2023, ChatGPT skyrocketed to fame as the consumer application with the quickest growth rate in 20 years of Internet history. [8] [15] Surpassing TikTok and Instagram, ChatGPT now boasts 100 million monthly active users. [8] [15] Since its launch in November, the chatbot from OpenAI has had everyone from Gen Z to Boomers hooked on its versatile ability to generate customizable written content. [8] [15] In fact, investors are caught in relentless competition to lead the funding race for Generative AI – AI that turns text prompts into images, essays, poems, videos and more. [3] [11] Data from Pitchbook reveal that venture capitalists have pushed up investment in Generative AI by 425% since 2020 to $2.1 billion in 2022. [11] With Google, Meta, Amazon and other tech giants experiencing major layoffs in the post-pandemic reality, does Generative AI threaten to replace human jobs? [2] What exactly is the story behind venture capital, leading to the rise of Generative AI startups?

Venture capital is a form of private equity funding that investors provide to startup companies and small businesses for their long-term growth potential. [7] The definition of venture capital involves three types of investing: seed, startup, and expansion investment. [9] After a company has undergone the early stages of seed and startup, it becomes eligible for expansion stage investing. [9] Compared to conventional capital markets or debt funding options, venture capital differs in a myriad of ways. [4] Venture capital firms not only invest time and funding into research, but they also identify and mentor prospective entrepreneurs in rising fields and technology. [4] Often, newness, smallness, information asymmetry, and uncertainty limit startups' access to traditional finance resources. [4] Venture capital firms, nevertheless, provide them with the necessary assets to facilitate and manage business activities. [4] Venture capital investment in America with high-risk high-reward could be traced back to as early as the whaling industry. [12]

The first modern venture capital firm was American Research and Development Corporation (ARDC). [5] [12] Established in 1946 by renowned individuals, including Harvard Business professor Georges F. Doriot, ARDC became a trailblazer for startups, raising capital without reliance on lending, mergers, stocks, or bonds. [5] [12] Like current venture capital firms, ARDC invested in technology companies, its major success being the 1957 Digital Equipment Corporation. [5] [12] In the same year, Doriot’s student, Arthur Rock, helped secure funding for eight founders to establish Fairchild Semiconductor in the Bay Area (Silicon Valley). [5] [12] A series of events in the 1970s would go on to further promote venture capitalism: the National Venture Capital Association was formed; the Employee Retirement Income Security Act allowed retirees to allocate up to 10% of their pension funds to venture capital investment. [12] By the 1980s, risky companies backed by venture capital developed exit strategies, creating major returns in some of today’s Silicon Valley names like Apple and Microsoft. [12]

In the early to mid-1990s, the emergence of personal computers paved the way for tech entrepreneurs and venture capitalists, as companies sought to expand via the Internet's budding opportunities. [5] [12] That was until the dot-com bubble burst, costing millions of dollars of loss. [12] History would repeat itself in the 2008 Global Financial Crisis and the 2020 COVID-19 Pandemic. [5] The venture capital industry stayed resilient, nevertheless, constantly adapting and setting a new record with more active firms and fewer exits. [5] Each development introduced new venture capital across locations, not limited solely to the U.S., which diversified the sources of investment for startups. [5] As the driving force behind American business sectors and tech giants over the past decades, venture capital investment has grown highly competitive in 2023, especially for the Generative AI industry. [6] [9] Why is this the case?

A possible reason lies in the mismatch between scarce Generative AI startups and the funds available for their future potential. [6] Only a few Generative AI start-ups have been fruitful due to the industry's scarce number of professionals, the majority of whom are working for big companies. [6] Success stories like OpenAI, Stability AI, and Jasper make venture capitalists desperate for another game-changer, offering AI entrepreneurs immense valuations even in their seed and start-up stages. [6] The fall of the Silicon Valley Bank, an institution that supported countless tech start-ups, didn’t alter the dynamic between the opportunities and funding available for Generative AI [6] The appetite for the transformative, growing technology maintains.

In fact, venture capitalists are looking forward to incorporating AI in their funding allocation process to screen start-ups and monitor company growth. [10] Nevertheless, the technology is not replacing human investors anytime soon, as it could only pinpoint good quality startups within the pool of successful past companies. [1] How can we be sure that Generative AI is not taking other human jobs? A recent report by Goldman Sachs economists, including Chief Economist Jan Hatzius, states that generative AI could replace up to 300 million jobs globally. [14] Historically, there has always been a displacement effect from new technologies, but their productivity impact continuously proved more dominant, inciting aggregate U.S. employment and economic growth. [13] After all, the Goldman Sachs report did also document a rise in productivity that could improve global GDP by 7% annually. [14] Independent investors and aspiring venture capitalists aside, generations across the globe can confidently look forward to rising innovation and long-term gains with generative AI.