‘Flavor of the month’: VC funding in AI is on the rise, but for how long?

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The conversation around artificial intelligence continues to swirl, including in the world of venture capital.

According to Crunchbase, North American startup funding was down 50% year over year in the first half of 2023. Further, in the first six months of the year, global funding hit $144 billion — 51% less than the $293 billion invested in the first half of 2022 and 10% less than the second half of 2022.

In November 2023 alone, Crunchbase reported that global venture funding reached $19.2 billion, compared to the $23 billion invested in November 2022 — which was already a two-thirds drop from November 2021.

But investment in AI startups is bucking that trend.

In 2022, 11% of venture funding went to AI startups, according to Crunchbase. By August 2023, that number had more than doubled to 26%.

Those numbers track what Nick Mathioudakis, a partner in the Indianapolis office of Faegre Drinker Biddle & Reath LLP, is seeing among his tech clients.

“I just think every, especially every technology-driven or technology-enabled, business is trying to leverage artificial intelligence,” said Mathioudakis, who co-leads the firm’s emerging companies and VC capital practice.

According to Mathioudakis, clients are considering AI in every business decision right now, but the process is the same as with the adoption of any emerging technology.

“There’s a time, right?” he said. “The early applications aren’t usually always the best applications, and people will find over time the more effective uses of artificial intelligence.”

The goal for clients, Mathioudakis said, is generally to find the best ways to leverage AI to increase efficiency.

“I think that’s why it’s so interesting right now because it is such a wide open and big opportunity,” he said.

Given that, Mathioudakis opined that investment in AI-driven companies — which span industries and aren’t necessarily tech-specific — will continue to rise. The overall decrease in VC funding, he said, has opened up an opportunity for investors to focus on the emerging technology.

“I think we’ll continue to see lots of investment in here as people see there’s going to be mergers and acquisitions involving AI, which is what attracts investment dollars into it, as well,” Mathioudakis said.

Just a phase?

Indiana University Robert H. McKinney School of Law professor Frank Emmert compared what is being seen now with AI with the interest in cryptocurrency in recent years.

“At that time, venture capital was going massively into that market and funding all kinds of projects,” Emmert — who teaches international investment law, among other courses — said. “Most of that didn’t really pan out. The big question now is, ‘Are we going to see a repeat of that scenario? Are we going to see a fad?’”

Emmert described AI as the “flavor of the month,” and he noted that the companies pouring billions into the industry often want quick results. If the returns on those investments aren’t seen in two-to-four years, he said, investors will move on.

Still, AI has broader opportunities than crypto, Emmert continued, which can work to its advantage — if one application of AI doesn’t work out, another might. He gave examples of ways AI is already being used, such as in self-driving cars, electric vehicles, robotics and transcription services.

But Emmert said he would rather put his money toward technology that’s already developed and is now advancing, rather than something brand new.

“We have to be careful because venture capital is becoming a very strange kind of approach, right? There’s too much money out there, and the money is looking for investment opportunities, and preferably opportunities that will yield enormous results, and preferably enormous results really, really quickly,” Emmert said. “To achieve that, they are willing to take a certain amount of risks, basically betting on horses knowing that some horses aren’t going to win, and the bets are quite substantial, right? We’re talking many millions of dollars that are being invested into projects that may or may not pan out.

“So there’s a lot of money,” he continued, “and the money needs to go somewhere.”

AI applications

At the Indianapolis law school, Emmert said he is developing and offering courses on AI and its regulation. Also, law school faculty and staff have already looked into ways the technology can be used in the profession.

Seth Wilson, an attorney at Adler Attorneys in Noblesville, gave the example of giving an AI tool a prompt and letting it undertake legal research in just a few minutes, compared to the hours it would take to do the research manually.

“I do think it’s going to be here to stay, and I think it’s going to continue to grow and connect with what we do on a daily basis,” he said.

Already, Wilson said, he’s using some AI in his own practice.

“We are always testing what’s available for us just to make sure that we are staying abreast of that change in the law and the technology associated with that,” he said. “We don’t do it for too much client deliverable work at this point, but more the kind of research and the explanation of legal concepts, so we kind of use it as an educational tool.”

Sometimes, Wilson said, a person might not even realize they’re using an AI tool.

“I think a lot of that AI stuff is going to show up in ways that we’re not even aware of,” he said. “If you think of cameras and stuff on your smartphones, they have a lot of computer processing power that’s happening in the background and you don’t even realize that that’s all kind of machine-driven or AI-driven.”

While the potential of AI is exciting, Wilson said, there is another side to the coin.

“It’s also scary because if you draw the conclusion of, ‘Are the machines going to take over and do all of our thinking for us?’ and that kind of stuff on artificial intelligence, you can kind of go down and swing the pendulum too far to the other end,” he said. “And so I think there’s some really exciting possibilities to sort of sense what it’s able to do and what that service you may be subscribing to is connected to — not just the wide open spaces that are out there, but your own data and how to point at your data and you’re able to utilize it in a specific way,” Wilson said. “That’s where it can get really exciting, what the possibilities may be of those services that can kind of connect with what you already do and make it better for you as the end user.”

Still, Wilson agreed with Emmert that it may be most beneficial for venture capital funding to go toward an already existing service.

“That’s where the VC dollars are probably going to be most beneficial is that existing service that has a pretty good user base and can leverage some piece of that to generate revenue — that will be the thing that the VC folks probably say, ‘Hey, here’s that quick pay,’” he said.•