How to invest when everything moves so fast

TechCrunch’s StrictlyVC evening in Los Angeles late last week brought together two of the most outspoken investors working in the AI ​​space right now. Carter Reaume is the co-founder of M13, an early-stage company with $2.5 billion in assets under management, and has served as a seed or Series A investor in 17 unicorns, he says. Zhang Xu is a partner at Basis Set Ventures, which launched in 2017 as one of the first venture funds focused exclusively on AI, and is now investing from its fourth fund, with nearly $1 billion in assets under management.

On stage, in a sunny room in El Segundo, the two were as entertaining as they were illuminating, covering how to price deals in a market that’s never moved so fast before, how to find companies that won’t be beaten by super-expanders, and what they’re up to in SpaceX’s IPO in Los Angeles. The conversation has been condensed and edited for clarity.

Is there an AI infrastructure bubble?

Zhang Xu: There is a bubble and not a bubble. It’s not a bubble because we’ve never seen this kind of growth curve before. ChatGPT goes from $1 billion to $40 billion in six months in terms of revenue – and that’s just unprecedented growth at this scale. Our portfolio company, Open Art, went from $1 million to $10 million in year one, and from $10 million to $70 million in year two. [and it was] Cash flow positive most of that time with only 20 people. The standard for good growth has completely changed. When you have that potential to double exponential growth, the valuations don’t look so crazy because you’re pricing that in the terminal value. On the other hand, if you price every trade according to those calculations, there’s no way it will work out well for the portfolio. So it is a paradoxical time.

Carter Ream: I always laugh because we pretend this is the first time in venture capital land, but we’ve seen this before — with the cloud, with the iPhone, with the car in the 1920s, when people were worried they were going to lose their jobs, and they did, and life went on. This is sharper and faster, but the same dynamic. What’s different about this tournament is that previous tournaments have had innovators versus innovators — Zuck versus Evan, Travis versus John Zimmer. In this cycle, you have innovators competing with innovators, competing with the biggest, most well-funded innovators of all time. and Competing with the ten largest technology companies on the planet. I would argue that for the first time in history, the incumbents actually have the advantage – technology, capital, data, and talent. So, the faster some of these companies go, the more likely they are to collapse. I actually find it difficult to invest in a market like this. But if you do it right, you’ll look like a genius.

How do you price deals when startups are generating revenue faster than ever but it’s not clear how sustainable it is?

Reum: We always do the cocktail napkin calculations. We were looking at a business that day – AI software for brands. I asked: How many winners were there in the last session? Will there be more brands in the world? Are they willing to pay double or triple the amount for the software in this course? We ended up not making the investment because we couldn’t do a math check.

what: We stay very close to defensible artistic differentiation, because those boundaries change every three months, maybe every month, sometimes even every week. The framework we are thinking about is investing under AI and above AI. Under AI, you have all this infrastructure being rethought — databases, version control, deployment tools — because it’s all designed for humans. Now you have agents using all of this infrastructure, and the agents require fundamentally different things. Last year I never thought you’d need a new GitHub. This year I can count on one hand the number of really strong teams striving to be GitHub for agents. Above AI, when things get too crowded, we always come back to: What is defensible, and what is differentiated in the long run?

how He does Are you investing in companies that won’t break up because of OpenAI, Anthropic, or Google?

Reum: We always try to think about where they will go first and where they will go last. It was clear that they would be looking for obvious marketing and locations. So we have a thesis about friction as a moat – we like regulated industries. We had an exit just shy of $1 billion in a company that disrupted 911 call centers using AI. The super-expanders may get there eventually, but as a result worth a few billion dollars, they won’t get there anytime soon. Health care – they will go there, but there are a lot of regulations that slow them down.

What keeps us all up at night is that it can change on a dime. You used to see them coming in the rearview mirror. I tell every founder: You need a microscope in one eye and a telescope in the other. The microscope is for everyday use – what should I do this week, get it done. But you better have your own telescope, because the world is changing very quickly. You must be a domino and chess player, because your board is constantly changing.

what: The framework we use is: Is this a depth market or a speed market? In speed markets, fast followers are faster than ever before – it’s all about speed of execution. In deep markets, the tough stuff is still tough. We actually have a company that uses genetically modified chickens as an alternative to manufacturing drugs, because complex proteins are very expensive to manufacture. It seems to be cheaper if you have chickens. Chickens still take a long time to hatch, even to this day [laughs]. These are deep markets, and we invest accordingly.

However, are you seeing really new ideas at the moment, or mostly new versions of old companies?

what: both of them. The consensus categories — proxies applying to finance, proxies applying to healthcare — see a lot of strong founders going after them, and a lot of them will win. But the most interesting ideas are the ones where you think, “Huh, I don’t know if this could be a business.” OpenArt, when we first supported them – shortly after that, Dall-E came out, Stable Diffusion came out, and they started a discovery page for prompts that you could write to get certain types of generative images. How does that work? Absolutely no idea. It went from $1 million to $70 million within two years and has accelerated ever since. There is so much depth in this market that we cannot tell it from the outside. But from the beginning, these were young founders experimenting on the cusp of something they found exciting, and they kept iterating until they found a business. If they had started a year later, they would have missed the window.

The story of venture capital is that it is always the story of turning bad ideas into good ideas again. Four or five years ago, you would have said that investing in anything sold to Hollywood was a bad idea. Then we did a bunch of deals in creative AI, generative AI, which led to the current wave of companies doing very well — generative images first, then video, and now universal models. This was a much bigger world than we expected given the previous generation of shows sold to Hollywood. Then you have the indicator, which everyone said was just an AI shell. $60 Billion Exit and Researchers – When my husband was doing his PhD at MIT, his salary was barely above the poverty line. Now the researchers are the ones everyone follows on Twitter.

Reum: I think we’re still in the early stages. The first wave of any technology cycle, even a sharp and rapid one, is usually the most obvious – more competitive, crowded. The second and third undulations are where it gets interesting. Think about when you were a kid: If you took a heavy rock and threw it as hard as you could and made it jump across the water, the heavier the rock and the faster you threw it, the longer the ripples would be. That’s what we’re going to get here. I’m excited two, three, four years from now, because there will be business models and companies that we can’t imagine today. As a venture capitalist, second and third bets on Ripple are the hardest to make – but if you do, fewer people consider it, you pay more reasonable valuations, and the ROI tends to be much better.

A SpaceX IPO will put a lot of money into the hands of people who live here in Los Angeles, especially employees. What does that mean for this ecosystem?

Reum: When Anthropic and OpenAI eventually IPO, there will be a combination of venture capital funds and institutional investors. Never before has so much money come back and been so widely distributed as it will with SpaceX. If anyone [in this room] He has a house for sale, a boat, and a plane – definitely take advantage of that trip. But more importantly, every major liquidity event generates a second wave. The previous Los Angeles cycle spawned things like Riot Games, Tinder, and Snap. This is a different order of magnitude.

Three years ago everyone said San Francisco was dead. It turned out to be less dead than people expected. I think the same goes for anyone who rules out Los Angeles. There are a lot of smart people here – technically, but also people who understand the brand, the content, the creatives and the impact. This first wave is an artistic wave, and artistic talent is concentrated elsewhere. But what comes after the technical waves? New business models, creative thinking, understanding culture. This will be the next wave, and I think there’s a good chance it will be centered in Los Angeles

what: The interesting thing is that the next frontier in AI is not more computing, but taste. It’s making films, making videos, making things that resonate emotionally, making things that connect to certain cultures. San Francisco has an extraordinary artistic talent, and this is also what models in automation and acceleration are good at. Los Angeles has great taste.