Earlier today we published a piece lamenting the difficult prospects facing the many start-ups chasing the market for AI accelerators. After writing that, we realized we were left with the question as to why there are so many seemingly very similar companies chasing a limited market. The answer is not going to win us many friends.
At heart, the problem is that the US Venture Capital complex has lost its sense memory for semis investing. We have written a lot about this (and here and here). If you forecast out technology industry revenues for the next 10 years 60+% will come from hardware, but over the past ten years only 10% of venture dollars have gone to hardware.
A few years before Chat GPT, we took an AI chip company into see one of the best known Sand Hill Road VCs, a company that helped fund many of today’s chip giants. We had a very warm introduction, but it took them a while to find us the right person to meet. He was a Valley veteran, someone who had done many of those early semis deals and he really liked the pitch. The problem was that by this point he was an emeritus partner, they had pulled him out of retirement to meet with us, and he no longer had the internal pull to bring his partners along with the deal.
To be clear, we are fully sympathetic about how this happened. For starters, early investing in semis is expensive. Three people in a literal garage can bootstrap a software company to multi-million dollars in revenue. But a chip company needs $50 million just to get its first product. And for the past fifteen years or so, returns on venture semis deals have been paltry.
These difficulties created a negative feedback loop. Junior associates who championed an investment in a chip start-up that had a bad exit remember that, and by the time they are senior partners still feel that bad experience and avoid the whole sector. If they even still have a job, as some of the deals done in the 2000’s turned out really badly. Either way, the end result is that the major venture funds have gradually shed partners with any knowledge of the sector.
VCs are smart and flexible. They know an opportunity when they see one. And so past waves of excitement around AI chips, like Google’s TPU, which clearly marked an important trend sparked a lot of interest from investors. The problem is that by the time the TPU came around, there was almost no one left in the Valley who had enough semis knowledge to accurately judge the market. We participated in multiple diligence project in the Teens where it was clear that the investors did hot have a good grasp of some chip start-up’s prospects. At times, it seemed like there was only one Valley firm left who really understood the market and they participated in almost every deal.
And so we ended up with multiple hype-cycles driving investments. The market, and LPs, see reasons to be interested in chips again, and investors pile in without a full understanding of the risks. This process has now repeated itself a few times, but the largely poor exits seen in the sector have only served to reinforce venture investors aversion to the sector.
It is noticeable that many of the very large AI accelerator fund raises that have taken place this year have been led by non-traditional venture investors. The best known firms all got their fingers burned by the first TPU-era wave, and have been mostly absent from the latest deals. Probably the best example of this is Sequoia which has published two pieces cautioning against the AI hype. Those notes are in part meant for Sequoia’s own LPs, explaining why the firm is not investing here.
The hardest part of all this is way in which a whole series of rational decisions have led to an undesirable outcome. While we lament the lack of venture investing in semis, we also understand the logic that got us here. We do not mean to criticize established Venture Investors, they all had good reasons for their actions. Unfortunately, decades of past practice and institutional memory make it very hard to right the ship. It is probably going to take a new generation of venture firms to get things headed in a more sustainable direction.
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