Venture Capital and Artificial Intelligence. And Vice Versa.
Who hasn't been surprised—or even excited—by the current capabilities of Artificial Intelligence and the speed at which it is evolving? Who hasn't also felt concerned about the potential job displacement it may bring in the short term? And, above all, who truly knows how this technology will reshape our professional and personal lives over the coming years?
This last question is particularly important, especially for investors specialising in early-stage companies and emerging technologies, such as Venture Capital firms. The reality is that AI is dramatically reducing the cost of building companies. And increasing their replicability. From software development, of course, to customer support, design, marketing, and an ever-growing number of business functions. This may be excellent news for entrepreneurs, who will be able to launch and scale startups with significantly less capital, albeit while facing much greater competition. But it is not necessarily good news for investors.
When technology becomes democratised and building a company becomes increasingly inexpensive, how should investors adapt? If AI changes the economics of startups, should it also change the economics of Venture Capital funds?
The traditional Venture Capital model consists of an investment period of four to six years, during which funds invest in ambitious young companies that require capital to grow, followed by another four to six years dedicated to exits, as those companies mature and strategic buyers are sought. In practice, funds typically have a six- to ten-year window from their initial investment, often complemented by several follow-on rounds in their most promising portfolio companies. During this time, startups build products, teams, customer bases and strategic relationships. They build a culture. This period has traditionally been considered the minimum required to create value and demonstrate sufficient revenue and profit growth to sell either the company—or at least the Venture Capital fund's stake in it—at a valuation significantly higher than the original entry price.
But if lower costs lead to greater replicability and more competition, companies may become increasingly short-lived. They may grow remarkably fast with limited resources, but other entrepreneurs will quickly seize the same opportunity, and they will be able to do so faster and more cheaply than ever before. As a result, the market opportunity available to each individual company will inevitably shrink. After all, there are not suddenly more customers—only the same people and businesses purchasing products and services.
Innovation creates temporary monopolies and extraordinary profits, but those profits inevitably attract imitators who gradually erode them. This is the principle of "creative destruction", first articulated by economists such as Joseph Schumpeter. AI will not change this dynamic—it will simply accelerate and amplify it.
Against this backdrop, two fundamental aspects of Venture Capital fund structures may need to evolve: fund size and fund duration.
If startups require significantly less capital both at launch and throughout their growth, very large funds become less necessary. It may become increasingly difficult to deploy capital efficiently while maintaining attractive return expectations when companies need relatively little funding or operate in markets that are already highly competitive—or that can become saturated very quickly precisely because of AI. Yet assets under management remain the primary economic driver for Venture Capital firms, as management fees are calculated as a percentage of capital raised. As a result, many mega-funds may ultimately need to reduce their scale dramatically—something that is rarely easy to achieve.
Fund duration may also need to be reconsidered. Eight- to ten-year structures may no longer be appropriate for a significant proportion of startup investments. If opportunities become shorter-lived but capable of generating substantial returns over relatively brief periods, investors may increasingly favour structures designed to maximise profit sharing over the short and medium term, such as Revenue-Based Financing. Such models would allow investors to receive a predetermined share of a company's revenues or profits for a limited period and within agreed parameters, creating stronger alignment between the evolving nature of startups, the structure of investment vehicles and the value that this relationship can generate.
Whatever the outcome, one thing is clear: something fundamental is changing. It is no longer enough to adapt our investment analysis and better understand the risks and opportunities facing new businesses, regardless of whether AI itself forms part of their value proposition. We must also rethink the very structures through which we invest, ensuring that the relationship between entrepreneur and investor continues to create as much value as possible.
And if there is one thing humans have always excelled at, it is adapting.
Sources in media: Funds People
