Last week, TechCrunch’s StrictlyVC event in Los Angeles showcased two straightforward investors in the AI sector: Carter Reum, co-founder of M13, and Chang Xu, a partner at Basis Set Ventures. Reum’s firm manages $2.5 billion and has invested in multiple unicorns, while Xu’s firm has nearly $1 billion under management and focuses exclusively on early-stage AI investments.
During their engaging discussion in a sunlit room in El Segundo, the duo shared insights on pricing deals in a rapidly evolving market, locating resilient startups amidst major tech giants, and the implications of the upcoming SpaceX IPO for Los Angeles. The following is a summarized and edited version of their conversation.
Is there a bubble in AI infrastructure?
Chang Xu: There are both aspects of a bubble and signs that it isn’t one. The growth we’re witnessing is unprecedented; for example, ChatGPT surged from $1 to $40 billion in six months. One of our portfolio companies, Open Art, increased its annual recurring revenue from $1 million to $70 million in just two years with a small team. The expectations for growth have drastically shifted. However, if every investment is adjusted based on that growth model, it might not be sustainable for the portfolio in the long run. It’s a complex situation.
Carter Reum: I often chuckle at how we behave as if this is new in the venture capital world. History has shown similar patterns with technologies like cloud computing and the iPhone. The dynamics are steeper this time around, but the essence remains: innovators have traditionally competed against each other. Now, they face substantial players with deep resources, data, and talent. This can make investing more challenging because while companies can rise quickly, they can also crash just as fast. If you succeed, you may be hailed as brilliant.
How do you determine the value of startups that are rapidly generating revenue, yet their sustainability is uncertain?
Reum: We often rely on straightforward calculations. We assessed an AI software venture recently and analyzed the potential size of the market and whether brands would pay significantly higher for such software. Ultimately, we decided against investing as the financials didn’t align.
Xu: We focus on the unique technical advantages of a company, which can change rapidly. We distinguish between underlying infrastructure needed for AI and applications built on that technology. Many foundational tools need rethinking now that agents use them instead of humans. I never anticipated needing a new platform like GitHub for agents, but there’s a growing demand in that area. We continually return to what constitutes a long-lasting competitive edge.
How do you invest in businesses that are unlikely to be overshadowed by major players like OpenAI or Google?
Reum: We analyze potential paths for these businesses. Certain sectors, like regulated industries, can provide a competitive moat; for instance, we had significant success with a venture bravely innovating within 911 call centers. While the tech giants might eventually enter these spaces, they may avoid them for now due to significant regulatory hindrances.
Every investor worries about the unpredictable nature of this market. Unlike in the past, where threats appeared gradually, startups today must balance immediate actions with long-term strategic vision. Founders need to focus on current tasks while also keeping an eye on emerging trends.
Xu: We evaluate whether a market prioritizes speed of execution or depth of expertise. Some markets are maturing quickly, while others remain complex. One of our portfolio companies is creatively using transgenic chickens to produce complex proteins efficiently, showcasing the depth required in some industries.
Are you encountering truly innovative ideas or mainly iterations of existing ones?
Xu: It’s a mix of both. There are some strong founders tackling established categories, but the most intriguing innovations often start from places of uncertainty. For instance, when we first invested in OpenArt, we were unsure how they could turn their concept into a viable business model. Yet, due to rapid growth, they achieved phenomenal success. The market depth was underestimated at the outset. Founders experimenting and iterating played crucial roles in their trajectory.
Venture capital historically involves the transformation of poorly received ideas into successful ventures. A few years ago, many overlooked investments in creative AI, but recent successes, especially in the generative sector, have proven otherwise.
Reum: We’re still in the early stage of this technological evolution. The initial wave tends to be the most apparent and competitive, but it’s the later phases where unique opportunities arise. Think about how throwing a heavy stone creates ripples: the more forcefully it skips, the broader the impact. I’m excited for the next few years, as we will witness business models that aren’t yet conceivable. Although predicting those opportunities is challenging, the potential for rewarding outcomes is high.
With the impending SpaceX IPO, what implications are there for the L.A. ecosystem?
Reum: When companies like Anthropic and OpenAI go public, it will primarily benefit institutional investors. However, SpaceX’s unique circumstances will inject vast amounts of capital into the local economy, notably benefiting employees. Major liquidity events often spark a secondary wave of innovation, similar to what previous cycles in L.A. produced like Riot Games and Snap, albeit on a larger scale.
Previously, many claimed San Francisco’s tech scene was dying, though it’s proving to be more resilient. The same can be said for L.A.; there are too many talented individuals capable of fostering new ideas and creative ventures. While current innovations may be technical, the subsequent phases will be driven by understanding culture and creative business models, likely centered in L.A.
Xu: The next frontier in AI focuses less on purely technical advancements and more on creativity and cultural resonance. While San Francisco excels in technical talent, L.A. brings a wealth of creative insights, which will play a pivotal role as AI evolves further.
