The AI Party Bubble- So You Think You Can Dance?


The startup world has been on a tear recently, driven by the explosion of interest in AI…and for good reason. AI has the potential to transform the technological landscape for a generation. There is a long way to go, but there is reason to be excited.

The venture world, recognizing this excitement, has joined the party. But unfortunately, at the AI party, most attendees have gotten way out of hand. Let’s focus on some of the more prolific offenders: The Lushes, the Revelers, and the Enablers.

The Lushes– “Who Cares About Valuation! It’s a Party!”
At every party, there are those who drink too much spiked Kool-Aid. And they stumble around, dancing in their own self-created euphoric bubble. And this leads to very bad decision-making. Case in point:

In just the past few days, I met with 3 early-stage entrepreneurs building innovative AI solutions, all with exciting ideas but without a product and solution set just yet. They each had less than $3M in revenue, and each just closed fundraising rounds at $500M-$1B pre-money. For those not as familiar with venture valuations, let me extend the analogy- To justify these valuations, you would need to have drank all of the alcohol, at all of the parties, every day, for at least a year. And this kind of financing happens every week.

After waking up hungover and damaged after the last tech bubble burst only a year or so ago, VCs and entrepreneurs have fallen right back into old patterns- chasing paper valuations rather than building businesses. They forgot the fact that you have nothing in venture until you exit, and that getting ahead of your skis leaves you face down in the snow. To ease their hangover pain, the Lushes decided to throw another party. A party makes everything feel so much better…for now.

The Revelers – “The Party Must Go On…At All Costs… To You.”
Then there are those at the AI party who are not drinking themselves, but happy to spike the punch. They will participate in and contribute to the euphoric bubble in any way possible. They too were in dire straits when the last bubble burst, but they knew it was a bubble all along, and they knew it was going to burst. They just didn’t care. As long as the party keeps going, they get paid. They win either way!

The Reveler VC’s goal is to get their Limited Partners buzzed enough to pile more and more money into their already oversized funds, and then allow them to come back to the well quicker and quicker for even more allocation. They know that deploying an oversized fund requires writing oversized checks into early-stage startups, and that means oversized valuations. They also know that these dynamics make it exceedingly difficult to generate venture returns. But by filling the bubble with as much hot air as possible, they can still raise bigger and bigger funds, and extract more and more fee income without producing actual returns for their entrepreneurs or their Limited Partners.

When the bubble inevitably bursts, the Revelers will keep the party going by refocusing everybody’s attention on the next one. Devious and brilliant at the same time! The joy of misaligned incentives.

The Enablers – “I Know I’m Gonna Regret This, but I Can’t Resist”
Our third group is potentially the most dangerous of all- the Enablers. These are the folks who are neither selling nor buying the euphoria story. They are the Limited Partners who know it’s all an illusion but will fund the party anyway. They rant all day long about a lack of financial discipline and the irresponsible deployment of their capital, but when the Lushes and Revelers want more money, they pull out their checkbooks and write another check, often tacking on an extra zero.

The Revelers fuel the fire because they feel comfortable on the bandwagon. Convenient choices are notorious for trumping wise choices. And FOMO (“the fear of missing out”) often trumps both. Like the Revelers, the Enablers are often playing with somebody else’s money, so the easy choice wins the day.

“Just because everybody is jumping off the Brooklyn Bridge, it doesn’t mean you should too!” -My Mom. That’s especially true when you openly acknowledge that you’re going to get a concussion. A glutton for punishment those Enablers.

The Morning After – “I’m Hurting Everywhere!”
Like all party bubbles, the AI bubble will burst too- and abruptly. When the lights turn on, the Lushes will wake with raging hangovers, the Revelers will lay low and bide their time, and the Enablers will mourn their losses, shift their attention to another shiny asset class, and follow the bandwagon in a different direction. And then there’s the after-party, where the real party pros, the Heavy Weights, make their appearance.

The Heavy Weights – “The After Party is Where It’s At”
Like everyone in the venture ecosystem, even the Heavy Weights attend the AI party; they just don’t participate in the shenanigans, despite the peer pressure. It’s easy to mistake these folks for light weights- actively observing, but not joining in the party. You’d be wrong! They are just waiting patiently until everybody is reeling from the blast, prices are low, and opportunity is rife. That’s when the Heavy Weights accelerate their investment activities. They too know that another bubble will inevitably come along, but when it does, they will be selling at its height- to the Lushes, Revelers, and Enablers lining up to buy again. That’s how you generate outsized venture returns. And at SineWave, that’s how we generate euphoria.