Artificial intelligence or AI is the new hotness as everyone rushes to get a piece of the action. While more and more firms are leveraging the technology, AI remains in its infancy, with predictions of greatness still largely unrealized. This is not the only time we have seen bullish investors rush into a sector, pumping valuations only to be disappointed in the near term. Both the private sector and public sector are setting high expectations for AI but it is not completely clear how AI will evolve in the coming years and how policymakers will regulate the sector.
Victor Basta, Managing Partner of Artis Partners, believes we may be in the midst of the next round of “Zombie Unicorns.” Aris Partners is a boutique investment bank supporting European and US tech firms.
The term Zombie Unicorn describes companies once valued at over $1 billion only to receive a haircut in valuation – perhaps a significant one. Basta notes that 787 firms achieved Unicorn status in 2021, but many of these firms raised money at inflated valuations. He adds that approximately 517 of these Unicorns failed to raise future funding after accomplishing this vaunted status.
Basta notes that while private markets have slowed, in 2024, only 72 companies were deemed to be Unicorns. But of this cohort, 44% were AI startups. He explains that several years have passed since the high valuations of the Unicorns, but these companies now need to exit in the next 1-2 years, but probably at much lower valuations, “perhaps sub $500m in the majority of situations, and even a fraction of that for some.” He believes that many of these companies “achieved relevance in their space,” but if it weren’t for their valuations, they would be viewed as promising exit candidates.
“We can draw parallels between the events of 2021 that produced this wave of ‘zombie unicorns’ and the state of the market today. Three years ago, a massive surge in VC investment was the primary cause of the spike in $1 billion valuations, with this sudden influx driving up prices much faster than expected. While there was no notable increase in funding levels last year, one industry attracted the vast majority of the attention – AI. Therefore, what was a general trend in 2021 could be restricted to a specific sector in the years ahead,” said Basta. “To prevent a repeat of previous events, it’s crucial that AI decision-makers recognise current market conditions are almost certain to bring about inflated valuations. Above the infrastructure layer, AI companies often do not need to raise large amounts of capital to scale.”
He believes founders need to hold realistic objectives otherwise they may be instore for disappointment. He said that the issue is not just founders but investors too as they need to be more disciplined bout funding firms without a clear use case and a lack of profitability.
“The current crop of ‘zombie unicorns’ are still capable of achieving exits at the profitability level they deserved from the outset, before their values were inflated. For the AI sector to avoid a similar fate, its growth stage incumbents should expand responsibly and avoid being drawn in by a burgeoning investment landscape.”
While the sentiment makes a lot of sense, a lot of private capital tends to have a herd mentality – chasing yield because someone else did. It can be hard to write off an investment when throwing good money after bad may be easier.