Should VCs worry about overvalued AI startups?

But with this abrupt growth comes a new set of challenges. Specifically, VCs seem to be overlooking the risks associated with investing in overvalued AI startups.

The potential risks of hasty investment in AI

The AI industry is growing rapidly, fuelled by massive investments by VC and private equity firms, as well as governments. According to recent studies, over $20 billion has been invested in Generative AI so far, up 425 percent since 2020. While this is good news for the AI industry, it can also be a cause for concern. The high level of investment has led to overvalued AI startups, with investors expecting faster and higher ROI.

When investors pour money into overvalued AI startups, they are indirectly creating an inflated perception of AI’s capabilities, causing unrealistic expectations of what the technology can achieve. This can result in a situation where AI startups are promising more than they can deliver, leading to poor performance, market disappointment, and the eventual collapse of the startup. In the long run, this could elicit a loss of trust in the overall AI industry, which would be detrimental to the sector’s growth and development.

The focus on profits and short-term gains can bring about ethical lapses too. Overvalued AI startups may be more focused on delivering a quick ROI, rather than on developing benevolent AI solutions. This could result in AI solutions that are biassed, discriminatory, or lack transparency—all of which hurt the long-term prospects for AI.

Despite the potential risks, VCs can still help create a healthy AI ecosystem.

Encourage transparency and accountability

Investors have to push AI startups to be transparent about their operations, risks, and challenges. AI startups should be required to genuinely disclose their data sources, algorithms, and decision-making processes to improve transparency, accountability, and oversight. This will enable investors to make informed decisions about the value and viability of AI startups, in turn helping AI startups to build trust with various stakeholders.

Focus on long-term growth

VCs must keep their focus on long-term growth, valuing ESG factors and ethical development of AI as much as short-term gains from their investments. On the other hand, AI startups ought to focus on embedding ethical principles into their AI systems and solutions, ensuring that their applications are transparent, fair, and unbiased. Encouraging ESG principles will ensure that AI investment contributes to society as well as the long-term growth and development of the overall AI industry.

Conduct rigorous due diligence

Performing rigorous due diligence on AI startups before investing is paramount. This will help identify any potential risks associated with the startup, such as overvaluation or ethical issues. It will also ensure that investors are putting their money in AI startups that are aligned with their values and goals, leading to better outcomes on the long run.

The AI industry is one of the most complex and dynamic sectors of the global economy, making due diligence on AI investment targets extremely challenging. AI-mediated due diligence mechanisms can help overcome these challenges, but only if they are as complex as the AI being considered. This is because AI is a highly nuanced technology, and simple or rudimentary due diligence methods cannot fully assess the risks and opportunities associated with it.

By using AI-mediated due diligence mechanisms of equal complexity to the AI being considered, investors can gain a better understanding of the AI, identify potential risks and opportunities, and make more informed investment decisions. Strategic decision making in this sector is particularly challenging, and AI-mediated due diligence is an essential tool for investors who want to succeed.

Promote education and public awareness

Educating the public about AI and its potential uses and limitations is crucial for building a healthy AI ecosystem. Investors have a role to play in promoting public awareness of AI technologies, open up about AI benefits and potential drawbacks, and rationalise how AI can be used safely and ethically. Well-informed individuals and society as a whole will be better equipped to engage with, question, and voice any concerns regarding AI and investment in it. This engagement can put greater pressure on AI startups and investors to prioritise ethical and benevolent AI practices.

Focus on real-world applications

Investors are also expected to inspire AI startups to develop solutions that have real-world applications and address tangible problems. By doing so, AI investment can contribute to the development of solutions that not only generate profit, but also contribute to tackling some of our most complex socio-economic challenges.