Venture capitalists race to land next AI deal on Big Tech's turf

In December and January, several venture capitalists from the US and Britain raced to Paris to vie for a stake in a new artificial intelligence company that could reshape how people work.

The startup they courted, Dust, consisted of just two people. It had not been incorporated yet. And it rejected a generous proposal by top investment firm Coatue Management among other offers, three people familiar with the deal told Reuters.

Sequoia Capital won, two of the people said, leading a sizable "seed" fundraising round of $5 million. Dust aims to build AI tools that improve white-collar workers' productivity.

Alphabet Inc and Microsoft Corp's rapid push on AI and the billions of dollars they are spending to gain an edge have heightened competition in Silicon Valley. Startups in the space are pulling in offers from investors to take on their Big Tech peers and are closing deals in several days instead of weeks. It is a bright spot for an otherwise slow venture-capital market.

"Big Tech companies with massive investments in AI are not going to let their incumbent distribution advantage slip away easily," wrote Konstantine Buhler, a Sequoia Capital partner who led the Dust deal and is scouting productivity apps on the belief that "disruption is inevitable."

There's an investment craze over generative artificial intelligence, the subset of AI that exploded in popularity with ChatGPT, the chatbot from startup OpenAI. Such Technology can create virtually any text, image or other content on command after having trained on the inputs of past data.

“VCs think this is the new internet,” a generative AI founder in the United States told Reuters.

Investment in such startups has ballooned to $5.9 billion since the beginning of 2022, up from $1.5 billion in 2020, according to data from PitchBook. While the closure of Silicon Valley Bank may hamper debt financing, venture capitalists said interest in funding AI startups remains high, especially for top early-stage founders.

Samir Kaul, a founding partner at Khosla Ventures, itself an early backer of OpenAI, said the firm is receiving way more generative AI pitches than just six months ago.

"Now you are getting this herd mentality" among venture capitalists, said Kaul. That means lackluster companies "will get funded," then "fail and give the entire sector, which is very promising, a black eye."

ChatGPT set off massive investment because "ninety-plus percent of venture capitalists are actually very risk averse. Until you see a real application, people don’t really dive in," he said.

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ChatGPT's human-like responses to any query made observers predict AI could disrupt search-engine technology, along with Google’s market dominance. Two months after its launch, Microsoft upgraded its search competitor Bing with a chatbot powered by OpenAI’s technology.

Investors sense opportunity, even for a sale if not an initial public offering; some are betting that AI startups might outpace bigger rivals, encumbered by their size.

You.com, a search engine company founded in 2020 and backed by Salesforce’s CEO Marc Benioff, has found new life from incorporating generative AI technology. It has attracted more attention from users and investors, handling millions of searches per day, the company told Reuters.

Jordan Jacobs, managing partner at Radical Ventures and investor in You.com, said the upstart was “an example of the right people with the right Technology and opportunity, that can disrupt even the most successful Business models in the world.”

Productivity tools including writing assistants such as Jasper and Regie.ai likewise have drawn millions of dollars in funding. These companies won business helping blog writers and salespeople do their jobs faster. But now, Big Tech has previewed upgrades for Google Docs and Microsoft Word that can draft marketing copy.

How Jasper and Regie.ai will fare once such rival tools roll out remains unclear. Regie.ai's CEO earlier told Reuters that its in-house expertise and sales focus set it up well, while a Jasper vice president said its AI that creates on-brand content across platforms distinguished it.

In such head-on competition, investors are looking for any technical advantage that could make a startup challenger stand out. Magic, a software engineering tool that can help write and edit code, is building its own specialized AI and user interface, for instance, said Jill Chase, partner at CapitalG who led its funding round. The company has raised $23 million in an effort to compete with Microsoft-owned GitHub.

Still, the biggest race at times is among investors themselves, pushing up valuations. Greylock recently passed on backing a founder who had 10 competing offers to lead a funding round, an unusually high number, said Saam Motamedi, a partner at the venture capital firm.

Deals that might take up to six weeks in so-called Series A financing are now wrapping up in as little as several days, he said.

“Everything we’ve done in AI has had many term sheets from most of our competitors. The entrepreneurs have the fortune of picking who they want to work with,” Motamedi said.

“You could describe the environment as exuberant or even excessive in terms of what’s happening,” he said, “but there is a lot of substance underlying it.”