Riding Waves or Making Them

Speaking of trends, AI is undoubtedly still the talk of the town. However, there's a thin line between genuine AI-centric innovation and mere AI narratives to lure investors

There has been much chatter around the viability of the classic seed model, especially in light of soaring post-money valuations of startups fresh out of accelerators like YC. It's easy to get swept away in the euphoria of such tales, but it's essential to discern fact from fiction. In my previous post, I noted that late-stage and growth investors were allocating more capital to seed-stage companies increasing seed valuations through participation in seed rounds. As an example, a founder of an AI-focused company reached out to me for advice this week on his seed round where he received a term sheet from a notable late-stage investor for $10M on a $40M valuation. High valuations can be a double-edged sword - while they may offer short-term gains, they might spell trouble in subsequent funding rounds when companies fail to grow into their valuations. It’s startup foie gras. A glimpse into the annals of venture history shows that Pinterest, Airbnb, Dropbox, Uber, Lyft, and many others, which command global attention today, had modest seed valuations. The narrative underlines the idea that rational pricing at seed stages bodes well for both founders and investors.

Venturing beyond conventional wisdom, there's intrigue around non-consensus opportunities. A decade back, SaaS might have been considered avant-garde, but today, it's practically run-of-the-mill. Many opportunities lie in understanding what the market hasn't grasped yet. Following fads is rarely the pathway to grand returns. Case in point: In 2015, when the business world was enamored by direct-to-consumer commerce, OpenAI, an entity focused on generative AI, came into existence. This instance emphasizes the need to look beyond the trends to spot genuine, transformative opportunities. Questions about the feasibility of traditional seed investing arise as sectors like AI demand millions merely to train models. Investment isn't just about pouring in money; it's a delicate balance of risk and reward. Embracing the trending theme might offer immediate markups, aiding short-term fund performance. Still, long-term viability requires a focus on inefficiencies and the fortitude to resist the allure of popular trends. With a nod to Joel Greenblatt, patience is arbitrage.

Speaking of trends, AI is undoubtedly still the talk of the town. However, there's a thin line between genuine AI-centric innovation and mere AI narratives to lure investors. To invest based solely on prevalent market trends, such as AI's current standing, can be a myopic strategy. Even in an AI-driven era, not every venture that dabbles in AI is destined for stardom. Nor will the entry points at outsized valuations provide outsized returns. A discerning eye will differentiate between entities that employ AI as a genuine value add and those riding the AI wave without a clear direction. At the same time, understanding prevalent market narratives aids in identifying potential oversights and consequent opportunities. And while the current debate revolves around the speculated AI bubble, it's essential to consider each entity on its merits.

However, beyond technology and trends, the success of any startup often boils down to the age-old tenets of product-market fit. With capital pouring in, many startups splurge before identifying a clear market demand, leading them astray. Contrary to popular belief, overcapitalization can pose a more significant risk than its opposite. With easy capital access, the temptation to deviate from the core vision can be high. The real challenge lies in resisting this temptation. True product-market fit doesn't entail a mad rush for scale; instead, it's about identifying what one can offer that the market desperately seeks. Essentially, it's about understanding the difference between being "better" and being "different." With that distinction in place, even modest funding can pave the way for monumental success.

Clinging to outdated models or fleeting trends can be perilous. As we move into uncharted territories of technology, the real competitive edge, outside of access, lies in the ability to adapt and discern genuine opportunities.

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