In 2023, two-thirds of venture capital investment went into AI-related businesses.
Much like the widespread adoption of mobile technologies 15 years ago, AI is poised to radically reshape the private internet market. But how?
This is just one of the questions we put to Gaurav Kittur, Global Co-Head of Internet Investment Banking, and Cameron Lester, Global Co-Head of Technology, Media, and Telecom Investment Banking, as they prepare to host hundreds of investors and company leaders at the Jefferies Private Internet Conference in Santa Monica, CA. They share their thoughts on AI, on the changing exit paths for private companies, the impact of regulatory and geopolitical challenges and much more below.
Q: How do you see investment flows shifting as we progress through 2024?
GK: Consumer spending is still the vast majority of the GDP in the U.S. and many other countries, but the funding for consumer internet businesses – from seed all the way to the growth side – has slowed to a trickle. Now we see all this movement into AI-related businesses, particularly toward the infrastructure required to build the best models. So, I see similarities to 2008 when you had significant capital flowing into the infrastructure and operating systems for mobile, which then subsequently spurred the creation of companies like Uber, DoorDash, Airbnb and so many others. Soon, basically every consumer-facing application will have an AI-component to it, but it still isn’t clear exactly what that will look like yet.
That is why our Private Internet Conference will have a combination of AI-first companies along with more traditional consumer internet companies that are searching for ways for AI to enhance their business.
CL: For over a decade, there was an unprecedented wave of technology investment and innovation driven by four big themes. One was the broad adoption of mobile computing and development of Apple's App Store and the Google Play Store. Two was the network effects of marketplace businesses – like Uber – and subscription businesses – like Netflix – that provide value to the consumer at a fraction of the cost. Three was the ability of brands to be completely created, discovered and grown digitally without ever having to first develop a brick-and-mortar presence. And four was the powerful unit economics of digital customer acquisition. This turbocharged the growth of so many businesses and yet each of these four themes is somewhat played out. Everyone’s on mobile, everyone has a digital presence and now Apple’s privacy changes have made customer acquisition harder.
It is causing a fundamental rethink of consumer internet business models and a big part of the solution will be finding ways to apply AI to consumer behaviors.
Q: What kinds of investments in AI are most compelling right now?
GK: We have seen these funding rounds for companies like OpenAI and Anthropic, which are really about making the AI-models more powerful. That requires a ton of capital because the only way that the models can get powerful is by training, right? The more data that you give it, the more reps effectively it gets, the stronger it becomes.
Then the question becomes what can this model do for you? Can you take it and plug it into a video editing app or a new game engine or a new music discovery platform? That’s where the next wave of discovery and business creation will come from. Some incumbent players will figure it out and they’ll get stronger, but some won’t, just like some couldn’t figure out mobile.
This will create the opening for some massive new companies in the next five to ten years. AI-investment might even enable meaningful competition for some very well established businesses, with just one example being Perplexity’s search engine offering. That’s starting to make a dent in a space where Google has had meaningful market share forever.
Q: Investment activity is slowly picking up, but investors are certainly being a bit more selective in what they fund. What are they looking for?
CL: The cost of customer acquisition through the traditional channels has become much more challenging. So, a strong organic word of mouth and natural organic growth model for customer acquisition is incredibly important.
A company really needs to show a path to profitability and expanding margin as well. Growth is always important, but you're not going to get a hall pass for growth without a logical way to bring the cost of the revenue together and then scale the profitability.
In a more disciplined environment, investors will also tend to put a higher premium on funding already successful entrepreneurs. So, you look at the deal where Jefferies just served as the Placement Agent for the food and delivery app Wonder in its $700 million growth equity raise. This company was created by Marc Lore, who previously sold businesses to Amazon and Walmart. That’s the kind of founder experience that will always help prospective investors sleep better at night.
GK: I’d add that you really need to be able to show product-market fit and that the unit economics work as you scale up the business. There have also been several instances in tech – like with FTX and WeWork – where a founder wasn’t operating with proper controls. So, I am also seeing a renewed focus on governance, management and the proper board structure of companies.
Q: Antitrust activity is escalating in the U.S. and around the world. What do see as the most significant political or regulatory risks for private internet investors?
GK: For years, the major tech companies moved into strategic segments via acquisition, but that window is essentially shut for the time being because of the regulatory scrutiny. That’s one of the factors that should help the IPO market open up over time because there is a lot of pent up demand.
Obviously, the regulation of AI will continue to be a subject of conversation – and companies in this space need to be a significant part of it – but it’s just too early to forecast what any kind of durable regulatory AI regulatory framework would look like.
CL: Geopolitical risk is becoming a significant consideration. There is a war in Europe and in the Middle East. China-U.S. relations are eroding. Investment dollars flowing into China are dwindling and funds that would have gone to China five years ago are now going to India or elsewhere in Southeast Asia. So I think investment committees will be looking very closely at where businesses are located, how they’re interacting with other regions and what kind of risks that may create. With that said, it’s important not to overreact to short term geopolitical developments. For example, Israel is enduring one of the most challenging periods in its history. But Israel’s resilience and economic fundamentals – an educated populace, an ingrained culture of innovation and entrepreneurship and increasingly deep capital markets – are all still there. That’s why Jefferies is still so committed to growing our presence in Israel.
Q: Aside from AI, what do you think will be notably different about this coming cycle of investment in the private internet space.
CL: We’ve talked a lot about how AI will transform consumer businesses but it will also have such a seismic impact on small businesses. The small business customer does not have the time to do customization and these large language models and AI can improve and make small businesses much more effective in acquiring their own customers and servicing them than ever before.
GK: The growing role of private equity is very interesting to me as it has been a player on the software side but it is also starting to pay much more attention to private and consumer internet companies. Thus far, sponsors have had interest in what you might think of as Web 1.0 companies, like Yahoo or Trip Advisor. But you will ultimately see sponsors looking at other more mature, highly profitable businesses where leverage can be used to enhance returns.
This has been a bumpy few years for the private internet market and the progress from here won’t be linear. But there is so must justifiable enthusiasm about the new technologies and entirely new business models that are about to be created.