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Investors warning about sky high valuation of AI companies

When it comes to valuations, AI is in a class of its own. But some investors warn about the sustainability of sky high valuation of AI companies, financial data company PitchBook says in a new report.

For years, fintech was the valuations champion at both the early-stage and, in particular, the late-stage, where it rode unassailed for years. Changes in the economic environment, like the shift in interest rates, coupled with a rush of hype for AI have delivered a two-punch knockout, with fintech falling to a distant second in valuations at both stages, the report says.

According to the company’s Q1 2024 US VC Valuations Report, valuations for early- and late-stage AI companies have far outpaced those in other verticals. 

In the first quarter, the median early-stage AI valuation was above $70 million and around $100 million for late-stage companies. 

“The report shows rising valuation trend is in stark contrast to the rest of the venture capital landscape: 

The proportion of flat and down investment rounds has reached the highest point in a decade, accounting for a combined 27.4% of all deals, according to the report.

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PitchBook says AI continues to be at the forefront of investors’ priorities: In April, Perplexity, the developer on an AI-powered search engine, raised $62.7 million at a $1.04 billion valuation . Back in February, Lambda, an AI cloud computing specialist, raised a $320 million Series C at a $1.5 billion valuation.

“But some VC investors are sounding the alarm over the sustainability of these sky-high valuations”, PitchBook says.

“We’re in that land grab moment. You have a lot of investors that maybe aren’t thinking fundamentally sound, willing to pay whatever price it takes to get in,” says Giuseppe Stuto, co-founder and managing partner at 186 Ventures.

Facing immense pressure not to miss out on AI, Stuto says that investors are rushing into deals not understanding the underlying business being built. With rising valuations, Stuto said he’s been priced out of deals.

“Still there is a silver lining: According to Stuto, AI has driven competition down in other categories, creating more attractive opportunities. He pointed to fintech as an example of a vertical that has become less competitive and is now easier to invest in”, the PitchBook report says.

“Other investors, while still bullish on AI, are urging a more diversified approach to the space. Tim Guleri, managing director of Sierra Ventures, said that his firm has been looking toward the application layer and not focusing exclusively on capital-intensive infrastructure investments.” 

Guleri said that a lot of the hype is overestimating AI’s impact in the short-term and that the current environment isn’t sustainable.

“The high valuations being paid for generative AI investments is high-stakes poker,” he said. “You cannot drive sustainable venture returns from this.”

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