Fears of a bubble in AI are giving some investors pause for thought
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Will growing concern about a bubble in the artificial intelligence (AI) sector get in the way of new start-ups raising the money they need to build the businesses? Venture capital firms in the US alone have this year invested $161 billion in early-stage AI companies according to data from Pitchbook, amounting to a huge bet on a technology that has yet to conclusively prove its value. Warnings about hype from a string of commentators in recent weeks – including the Bank of England – have caused nervousness on listed equity markets. Some entrepreneurs fear that anxiety could spread to venture capital and private equity, damaging their efforts to raise money.
However, Omar Darwazah, general partner and managing director of early-stage VC firm AAF Management, thinks founders shouldn’t be too concerned. “It’s really a story of two different worlds,” he argues. “There are a handful of very large private companies that have been flooded with liquidity and seen huge valuation increases, but that’s not been the experience of those small start-ups that are looking to raise their first $1 million to $5 million.”
Indeed, Darwazah is prepared to put his money where is mouth is. AAF is today announcing the close of a $55 million vehicle, The Axis Fund, that will actively seek to back very early-stage technology businesses – those at the pre-seed and seed rounds of their development. “We believe that is where investors need to have more exposure,” adds Kyle Hendrick, also a general partner and managing director at AAF.
The Axis Fund will take a slightly different approach to deploying its funds than conventional VC vehicles. Around 20% of its capital will be allocated to existing VC funds run by what it describes as “emerging managers” – that is, small investment firms that have just begun to build a track record and have close relationships with technology start-ups on the ground. Those relationships will enable the fund to build an index of around 750 potentially exciting start-ups and scale-ups – leveraging the data of the emerging managers – from which it will look for candidates to make direct investments with the remaining 80% of its assets.
It’s a strategy designed to ensure the fund is able to identify investment opportunities that might otherwise fly under the radar, explains Darwazah. “The challenge for the VC sector is access,” he says. “It’s about getting access to the companies that will go on to become household names at as early a stage as possible.”
Certainly, it’s a model that appeals to AAF’s own investors. The Axis Fund has been anchored by Mubadala Capital, the Abu Dhabi sovereign wealth fund, and also has backing from a number of family offices and asset management firms. The involvement of these larger investors gives start-ups an opportunity to begin building the relationships that will underpin further fund-raisings in the future, AAF points out.
AAF’s own track record of identifying those “household names” of tomorrow is also part of the story. Previous funds raised by the firm have taken early-stage stakes in unicorn technology companies including Jasper, Current, Flutterwave, Drata and Hello Heart.
Hendricks believes there will be more such winners to come – and that the hype around AI will begin to dissipate as the technology is put to use. “We’ll stop thinking of these companies as ‘AI businesses’ as we focus on what their AI-enabled software delivers,” he says.
That prediction will be welcomed by many founders and entrepreneurs just beginning to build new businesses that leverage AI. The danger for them, particularly if warnings of a correction on listed equity markets prove justified, is of getting caught up in the bursting of the AI bubble.
