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Considerations for Evaluating AI Startups in 2023

AI | Dec 4, 2023

AI is a game-changer, reshaping how startups innovate and deliver services.

AI Is changing the startup landscape forever.  For instance, AI-driven platforms like Wealthsimple in Canada have revolutionized personal finance management, offering automated, algorithm-driven financial planning services. In the US, companies like Affirm and Robinhood are leveraging AI to personalize investing and credit services, making them more accessible to a broader audience.

Across Europe, startups like Revolut and Klarna are using AI to enhance user experience and security, offering real-time fraud detection and tailored financial products. These examples underscore a significant shift towards AI-driven personalization and efficiency in financial services.

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For investors, this shift means looking beyond traditional metrics and considering the innovative potential of AI in transforming financial services. The ability of AI to process vast amounts of data for insights, risk assessment, and customer personalization presents a new frontier for investment opportunities.

Founders, on the other hand, must focus on leveraging AI to address specific financial challenges, ensuring compliance with evolving regulatory standards, and maintaining ethical standards in data usage.

Evaluating AI Startups

NFX has recently published the 5-Level AI Spectrum offering a high level framework for assessing AI startups by categorizing them into one of the following buckets:

  1. AI-Enhanced Companies: Basic AI integration to improve existing processes.
  2. AI Product Extension: AI as a locking mechanism for Product-Market Fit (PMF).
  3. AI-Enabled: Central algorithm learning from core data to create new products.
  4. AI is the Product: AI as the central selling point, solving significant problems.
  5. AI-First: Companies that are inconceivable without generative AI, creating entirely new markets or products.

The concept of AI leapfrogging is particularly significant. It refers to industries that have been relatively untouched by previous tech waves, like Cloud or SaaS, jumping straight into AI solutions. This leapfrogging presents unique investment opportunities in sectors like legaltech, healthtech, and education, where AI can address challenges that were previously insurmountable.

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Addressing gender imbalance and diversity in the AI field is crucial for developing unbiased and representative AI systems, which is essential for ethical and effective AI solutions.

It's advised to look beyond the hype when evaluating AI companies, focusing on factors like the strength of the economic moat, clarity of market opportunity, team speed and technical prowess, and long-term defensibility. This perspective is essential in an era where AI is often surrounded by hype, ensuring that investments are made in companies with substantial and sustainable business models.

Unsplash Greg Rakozy person looking into space - Considerations for Evaluating AI Startups in 2023

Image: Unsplash/Greg Rakozy

The Emergence of AI-First Companies

AI-First companies, represents the most transformative category as Techcrunch highlights. These are businesses that couldn't exist without AI, often creating entirely new markets or products. For investors and founders, this level is a hotbed of innovation, offering the potential for high growth and significant market impact.

  • AI-first companies create and sustain an undeniable data advantage. This involves not just amassing large datasets but developing 'designer datasets' uniquely suited for high-performance tasks. These datasets are often not found in public domains and require creative acquisition strategies.
  • This technique is vital for AI-first companies. It involves an AI system learning and improving through feedback from expert human input. This approach is particularly effective in domains requiring specialized knowledge, like neurology or structural biology.

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  • Recruiting and empowering AI scientists is crucial. AI-first companies need teams with deep AI research acumen. These scientists are not just implementers but are at the forefront of advancing AI as a science.
  • Building an AI-first company requires investors who are willing to take a long term investment view. These companies often need more capital and may have less conventional business models compared to AI-enabled companies.
  • It's essential to distinguish between AI-first and AI-enabled companies. AI-first companies innovate at a fundamental level, just above silicon, and have the potential for greater impact, superior financial returns, and more enduring moats compared to AI-enabled companies that create value at the application level.

These insights are crucial for anyone looking to build or invest in an AI-first company, highlighting the unique challenges and strategies involved in leveraging AI at the core of business innovation.

Regulatory Landscape

The state of AI regulation varies significantly across different regions, reflecting diverse approaches to managing the rapid advancement of AI technologies. Here's an overview of AI regulation in key areas, including Canada:

  • The European Union is at the forefront of AI regulation with its proposed AI Act. This comprehensive framework categorizes AI systems based on risk levels and sets stringent requirements for high-risk AI applications. The Act aims to balance innovation with consumer protection and ethical standards.
  • Post-Brexit, the United Kingdom is adopting a "pro-innovation" approach to AI regulation (see Policy paper Aug 2023). The government has indicated a preference for observation and future regulatory frameworks as needed, focusing on collaboration with AI companies to ensure safety without immediate heavy legislation.
  • The United States has taken a "light touch" approach historically, but recent developments indicate a shift towards more structured regulation. President Biden's Executive Order on AI emphasizes safety and ethical use across various federal agencies, signaling a move towards more comprehensive federal oversight.

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  • Canada's approach to AI regulation focuses on ethical AI development and usage. The Canadian government has been proactive in establishing guidelines and frameworks, such as the Directive on Automated Decision-Making, which aims to ensure transparency, accountability, and fairness in AI used by government departments. Canada also emphasizes AI research and development, particularly in ethical AI, and positions itself as a leader in responsible AI practices.
  • China has implemented swift and specific Generative AI regulations, particularly in response to advancements in AI technologies. The Chinese government's approach includes stringent controls on AI content and requires security assessments for AI services, especially those with potential public opinion influence or subversive activities.

Looking Forward

Investors need to adopt a nuanced approach, focusing on the innovative potential of AI and its ability to redefine financial services. The emergence of AI-first companies, especially in sectors ripe for AI leapfrogging, underscores the vast potential of AI in creating new markets and solutions. As the regulatory landscape continues to evolve across regions, including Canada, the focus on ethical AI development and usage becomes increasingly crucial.  Investors should focus on the long-term viability of a project over short-term hype.


NCFA Jan 2018 resize - Considerations for Evaluating AI Startups in 2023The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, artificial intelligence, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org

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