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Tech startups are going through tough times as a result of a slowdown in growth capital. Investment firms are advising their portfolio companies to extend their runway. Companies are suffering from valuation markdowns and resorting to layoffs to cut costs. 

The artificial intelligence (AI) market is no exception. The CB Insights State of AI report for Q2 2022 shows global funding for AI startups dropped for the third consecutive quarter with a 21% decrease quarter-over-quarter. Mega-round fundings (i.e., rounds of more than $100 million) have seen a 33% drop quarter-over-quarter and only 12 new AI unicorns were born, the lowest since Q4 2020.

At the same time, the market has seen a 116% increase in exits – 90% of which are mergers and acquisitions, indicating that startups are gravitating toward large and financially stable companies as they continue to face cash problems.

However, amid the economic downturn, some AI startups have had no trouble raising huge investment rounds. And they hint at where the AI market might be headed in the near future.

Research labs led by AI celebrities are hot

Among the recipients of top equity deals in 2022 are AI research labs Anthropic ($580 million in series B) and Inflection AI ($225 in venture capital).  

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Anthropic’s website describes the lab as “an AI safety and research company that’s working to build reliable, interpretable and steerable AI systems.” It further says that it aims to address the unpredictability, unreliability and opacity of current AI systems. The company acknowledges that it’s currently focused on research with foreseeable opportunities to “create value commercially and for public benefit.” Since its founding in 2021, the company has released several research papers on transformer neural networks, large language models (LLMs) and reinforcement learning. 

That, by itself, doesn’t sound like a convincing pitch to make during an economic downturn. But perhaps what makes Anthropic interesting is that it was cofounded by Dario Amodei, the former VP of research at OpenAI.

After the $580 million fundraise in April, Amodei declared that the company will “explore the predictable scaling properties of machine learning systems, while closely examining the unpredictable ways in which capabilities and safety issues can emerge at scale.”

Research on safety and interpretability are crucial to the application of AI in the real world. But it’s also expensive, especially when it is applied “at scale” as Anthropic aims to do. Large-scale machine learning models are expensive to train and run, which suggests that Anthropic will soon need to raise more capital or find a large tech company that can monetize its technology. 

Inflection AI, the other research lab that has secured a megadeal, presents itself as “an AI-first company, redefining human-computer interaction.” Inflection aims to leverage recent advances in AI to develop the “ability to relay our thoughts and ideas to computers using the same natural, conversational language we use to communicate with people.”

This suggests that the company will be focused on LLMs, an exciting and costly area of research that still has many challenges to solve. The company was cofounded by Mustafa Suleyman, cofounder of DeepMind, and Reid Hoffman, cofounder of LinkedIn. The company has also recently recruited AI scientists from Google and Meta, according to CNBC.

Inflection launched in March with $225 million in funding from Greylock Partners, a VC firm that counts Suleyman and Hoffman as its partners. Given the costs of research and talent the company is facing, this probably won’t be the last we hear of it securing megadeals.

Healthcare, fintech and retail AI startups still raising funding

There is no shortage of ideas to apply AI to real-world applications. But during the downturn, areas of applied AI with more promising results continued to raise funding while others stagnated.

According to the CB Insights report, retail tech AI funding increased 24% in Q2 2022, nearing its pre-downturn levels. The biggest winner was Faire, which raised two rounds of extension to its series G funding, totaling $596 million. 

Faire is a marketplace that connects indie brands with local retailers that can sell their goods. It uses machine learning at different levels of its platform, including matching the supply-and-demand side of the market, helping brands better present their catalogs and profiles, optimizing search and recommendations for retailers and managing risk.  

Funding in healthcare AI decreased by 20% in Q2 2022 but is still doing much better than many other sectors. The biggest deal went to Biofourmis, which raised $300 million in series D. Biofourmis uses machine learning to monitor patients and predict diseases. The company uses hardware sensors paired with FDA-approved software that continually analyzes biomarkers, like heart rate, temperature and respiration rate. Predictive models have much potential to improve patient health and reduce the costs of care.

Fintech AI has managed to maintain its funding levels. The biggest deal went to Germany-based Taxfix, which nabbed $220 million in series D. Taxfix is a mobile assistant for tax returns. Users give the app a snapshot of their payslip and fill out a few additional details. The app provides them with their tax situation and estimated refund. For a premium, the app will also file taxes on the user’s behalf. The company uses machine learning and rule-based AI to automate the process of filling out tax forms and filing taxes. With its growing user base, the company, valued at $1 billion after the new round of funding, will now focus on expanding to new markets and creating new products to extend its touch points with customers beyond tax season.

Tricky times for AI startups

As capital becomes scarce, AI startups that are venturing into uncharted lands will find it harder to get funding. AI luminaries seem to be the exception to the rule, and they will continue to attract investors who have room to wait for long-term returns on investments.

AI companies that have already established their product/market fit and have a solid user base will also have a greater chance of raising funding during the downturn, as investors will be looking for startups that are ready for aggressive growth and, given enough capital, can shortcut their path to profitability.

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