Venture funding up, mainly AI

“Definitely the first half of this year compared to the back half of last year, and the first half of 2023, has been a lot better,” said Vignesh Ravikumar, partner at San Mateo-based Sierra Ventures.

But the market is also bifurcated, he added, between generative AI-focused companies and those that are not. 

“There’s a different valuation and round size … founders that are not gen-AI native are taking a little longer to raise those rounds,” Ravikumar said. 

Three of the top five deals in the Bay Area last quarter position themselves as AI-focused companies, including not just xAI — which raised a whopping $6 billion round, accounting for one third of total venture funding in the Bay Area last quarter —  but also Xaira Therapeutics, a South City-based AI drug discovery firm that raised a $500 million Series A round. Several of the top five deals went to other companies based or located in San Mateo County as well, including Stripe and xAI. 

The AI boom has been particularly lucrative in the Bay Area, which receives the highest proportion of such funding, much of it going toward firms such as OpenAI and Anthropic, which require vast amounts of computing power and therefore capital.

But the steep AI investments also have a psychological aspect to it, CB Insights Managing Analyst Benjamin Lawrence said.

“In general, investors think that they’re ahead of the curve and forward-thinking, but what you see is this mass form effect, and once you have something that takes off and becomes a common part of the investment lexicon, a lot of other people want to flock to it. AI is that case,” Lawrence said. “There’s a lot of companies that are getting funded that probably should not be getting as much money as they’re getting.” 

While attaching the “AI” label to a company may sound more enticing to investors right now, it probably won’t be so relevant in the coming years, as the technology will become ubiquitous, he added. 

“What I expect to see is possibly a drop in the next five, 10 years from now within AI funding, not because it’s being used less but because it’s not considered a product but a feature,” Lawrence said. 

While overall venture funding has increased, the number of deals in the region last quarter, about 2,400, is still the lowest number since before the pandemic. Part of that is due to the capital-intensive needs of model-developing AI companies, of which there’s only a handful of leading firms. But it’s also because the startups that raised money during the pandemic haven’t maintained or exceeded the valuations they received at the time. 

“The companies that raised at higher prices in 2021, 2022, given the market corrections now, need to find a way to grow into those multiples,” Ravikumar  said. “Therefore you don’t see all of those guys rushing into the market. On the flip side, the AI companies are getting a lot of attention from the market, and they take more money to raise.”

The exit landscape has also slowed, partially explaining the higher concentration of funding going toward large, later-stage deals, rather than spread across more earlier stage companies.  Mergers and acquisitions have been under more scrutiny the last several years, something Lawrence said is one of the few efforts with bipartisan support. And with the initial public offering market also slowing down, more companies are opting to raise larger rounds. 

Figma, for instance, raised $416 million in a Series F round last quarter, after its proposed $20 billion deal with Adobe was blocked at the end of last year. 

“Usually at that point you would IPO in your average market, but the average market is not looking that great right now,” Lawrence said. 

Both Ravikumar and Lawrence also added that they’ve seen more traction within quantum technology, which applies quantum mechanics principles to enhance data processing performance. The federal government has ramped up investment, more than doubling its funding to the technology between 2019 and 2023. 

“Quantum is a bit like AI, in the sense that there’s a very high degree of national interest that gets tied to who can win the quantum race,” Ravikumar said. “Quantum can theoretically break modern-day encryption and things like that … so governments are spending more resources on it.”

But for now, AI, especially generative AI and model development, remains the focus, with no signs of slowing down. 

“A lot of the foundational, large language model, gen-AI companies, I look at as the new big tech,” Lawrence said. “They are in the early days of it, but they are still quite potentially the new big tech.” 

alyse@smdailyjournal.com

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