Generative AI Startups Flourish but Non-AI Companies Fall Behind

The Mexican early-stage investment market is witnessing a pronounced split as generative artificial intelligence (AI) startups receive soaring valuations while non-AI companies grapple with a challenging landscape. This split has captured the attention of investors, prompting discussions around the need for AI regulation. The disparity in valuations reflects the industry's focus on two distinct criteria: the potential of generative AI and tangible revenue for other startups. 

Generative AI startups experienced a remarkable 16% increase in median pre-money valuations for early-stage rounds in 2023 compared to 2022, according to PitchBook data. Investors are displaying unwavering confidence in the transformative potential of these ventures, even in cases where revenue is minimal or non-existent. Rewind, a startup specializing in recording and archiving digital interactions, attained a valuation of US$350 million based on revenue of just US$700,000. Similarly, LangChain, an AI startup with minimal revenue, secured a valuation of over US$200 million in a funding round led by Sequoia. "The bifurcation is huge," Sundeep Peechu, Partner, Felicis Ventures, told Pitchbook. "There is a general euphoria that, 'wow, generative AI has revolutionary potential.'" 

Conversely, non-AI startups are facing a different reality. Valuations for Series A or Series B funding rounds have plummeted by nearly 24% for startups in non-AI sectors as investors seek concrete revenue growth. Yash Patel, Partner, Telstra Ventures, noted that startups can now expect valuations of only five times their next-12-months annual recurring revenue (ARR), compared to the previous benchmark of ten times ARR. The shrinking pool of companies qualifying for Series A funding reflects startups' challenges in generating revenue growth. 

"I am seeing a lot more companies going out to raise a Series A that are frankly not ready to raise a Series A," says Julius Schwerin, Partner, RTP Global. "The quality of companies raising is not where it was even during the boom time of VC in the last year or two." The slowdown in revenue growth is a shared concern among industry experts. An accounting firm specializing in early-stage startups Kruze Consulting reported a significant drop in revenue growth for early-stage startups in 2022. By the end of that year, revenue increases had slowed to less than 60% for early-stage SaaS startups, compared to approximately 100% growth in the previous year. E-commerce startups experienced an even more pronounced deceleration in growth. 

Amid these contrasting dynamics, the issue of AI regulation is gaining traction. Sam Altman, CEO, OpenAI, has called for government intervention in regulating the use of AI. However, a report by consulting firm Baker McKenzie suggests the possibility of self-regulation by companies to establish best practices in AI usage. The report highlights the need for well-defined internal corporate policies to mitigate future litigation risks.

"We have seen internal regulations that indirectly address the issue by including express prohibitions on the inclusion of company data that may violate confidentiality law, or personal data that may be considered sensitive data," said an expert from Baker McKenzie to Yahoo Finance.

As the Mexican investment landscape evolves, the divergence in valuations between generative AI startups and non-AI companies underscores the differing criteria investors use – one based on revolutionary potential and the other on concrete revenue. The ongoing discussions on AI regulation and the evolving challenges faced by non-AI startups in generating sustainable growth may shape the sector's future trajectory.