End of FOMO: Venture capital firms turn cautious over AI startup hype demand models with clear returns and impact

Adith Podhar, general partner at Gemba Capital, said the hype over AI startups is unlikely to be sustained because investors are becoming more cautious.

“Market correction is anticipated, with a focus shifting toward companies that can present a solid value proposition rather than those merely capitalising on the AI hype without a strong business case," Podhar said.

Investing in AI has matured from simply being a fad to the emergence of models that are able to demonstrate their value proposition, business impact, growth metrics, and potentially measurable returns, said Abhishek Prasad, managing partner at Cornerstone Ventures.

Investors have moved away from blindly pumping money into the AI hype to focus on areas that deliver significant value.

“Investors becoming more discerning is a positive development. It’s pushing startups to refine their value propositions and gear up to deliver real, sustainable growth. This evolution means that resources—both financial and human—are being directed toward ventures with the potential for significant future impact," said Vikram Chachra, founding partner of 8i Ventures.

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In the near term, Podhar sees a rationalisation of valuations and a slowdown in capital deployment, with fewer funding rounds taking place.

“Historically, any new technology has experienced a boom-and-bust cycle before achieving widespread adoption, and we believe that the AI cycle is still in its first innings," Podhar said.

In the past few months, three-AI focused startups - Toplyne, Nintee and InsurStaq.ai - have shut shop. According to posts by the founders of Nintee on its website and Toplyne on X, both startups returned money to their investors. The founders of these startups did not immediately respond to Mint's request for comment on Wednesday.

Industry executives suggested that the number of AI startups that have wound up in recent months runs in the thousands.

What’s working

However, there has been a surge of investor interest in the Generative AI space, leading to significantly higher valuations compared to non-AI tech companies, according to Podhar.

“AI startups at the seed stage command median valuations approximately 20% higher, escalating to 59% for Series B rounds compared to non-AI focused startups," he explained.

Models such as agents, co-pilots and solutions that help enterprises become AI-ready are highly investable right now, said Preeti N Sampat, a partner at Eximius Ventures.

“These areas are still in their nascent stages and have significant potential for growth as businesses move toward more autonomous operations," she said.

There are clear apprehensions about models that claim to completely eliminate the workforce. According to Prasad of Cornerstone Ventures, models with 'humans in the loop' are the ones that will see the most amount of success. It’s key to focus on 'Augmented Intelligence' rather than expect AI capabilities delivering high-value impact independent of human interventions, Prasad said.

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Shyam Menon, a partner at Bharat Innovation Fund, noted that vertical-specific AI solutions that lower operational costs, boost productivity, and provide return on investment within 6-12 months are attractive at the moment. Investors are wary of broad, horizontal AI platforms without clearly defined use-cases, especially ‘AI for everything’ solutions, according to Menon.

“Business to consumer (B2C) applications with unclear monetisation pathways, high customer acquisition costs, or those that require extensive data and infrastructure are viewed with scepticism," he added.

India’s AI market is projected to touch $17 billion by 2027, growing at an annualised rate of 25-35% from 2024 to 2027, according to a February 2024 report by the National Association of Software and Service Companies and consulting firm BCG.

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