Making sense of venture capital's AI paradox
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Illustration: Aïda Amer/Axios
Early-stage venture deals keep getting bigger, even once stripping out AI juggernauts. And that raises a multi-billion dollar question:
- If AI is supposed to supercharge productivity, why are startups raising more money? Shouldn't they need less?
By the numbers: Median early-stage round sizes are up year-over-year for most industry sectors, easily outpacing inflation, according to Q1 data compiled by PitchBook and provided to Axios.
- Not just in software, which includes many AI developers, but also in pharma/biotech (+29%), media (41%), IT hardware (71%), health-care systems (30.5%), and energy (79%).
- For PitchBook, "early-stage" means the company must be less than five years old and, if a series is specified, it should be an A or B.
The best explanation for this disconnect may be that AI hype hasn't yet translated into a ton of actionable use cases.
- The top ones so far are coding assistance and customer service automation, both of which can drive down startup costs but aren't necessarily game-changers.
- This is far different than when cloud computing took hold, dramatically cutting startup costs for both equipment and real estate (and, arguably, leading to the NYC tech boom).
- There also are some real-world cost increases, like Bay Area housing, but VC round sizes are climbing at a much faster clip.
The more cynical explanation may be that round size doesn't always match a startup's capital requirements.
- Venture capitalists often have their own calculus, tied to fund dynamics and ownership stake thresholds. Or the desire to use money as a competitive moat, particularly if they view a startup as operating in a winner-take-all market.
- Founders often lament taking more funding than they want, but either don't have better options or let future fundraising fears win out.
- Sometimes both sides are aligned on the gluttony, since larger checks can correspond to larger valuations.
Finally, there's the academic explanation of Jevons paradox, formulated by a British economist 160 years ago, whereby increased efficiency can lead to increased consumption.
- It's mostly been debated around areas like energy and agriculture, but soon may come to AI.
The bottom line: Venture capital talks a ton about the AI revolution, but so far is putting too much money where its mouth is.
