Generative AI startups were already hot with VCs. ChatGPT poured gasoline onto the fire.

• Generative AI firms, the category that ChatGPT falls under, saw big valuations in the past year.
• VCs investing in AI say they're optimistic and ready to invest in more companies in the space.

Generative AI, the technology that encompasses ChatGPT, DALL-E, and Lensa AI's avatar service, went bonkers viral in 2022. But even before the rise of ChatGPT, the space was buzzing as generative AI companies began raising large amounts of cash from venture capital.

Startups using generative AI rose eyeball-popping amounts in the past year, especially during an overall bad year for VC investments. Jasper, which makes AI-powered marketing materials, raised $125 million in Series A funding. Meanwhile, Runway, one of the companies behind Stable Diffusion, the model that powers Lensa AI, got $50 million in Series C, according to BuiltNYC.

Generative AI valuations are high, and VCs are excited. With VC investments falling, generative AI will at least be a bright spot in — and possibly the only bright spot in what look's to be a very gloomy 2023.

Complimentary Tech Event

Transform talent with learning that works

Capability development is critical for businesses who want to push the envelope of innovation.Discover how business leaders are strategizing around building talent capabilities and empowering employee transformation.Know More

A hot market gets even hotter

Investing in generative AI and machine learning is nothing new for VCs. But the wild success of ChatGPT and the promise of even faster advancements has investors more excited than ever.

Partially thanks to the millions of people beta testing ChatGPT this winter, the next version of the tech that makes ChatGPT possible is due out as soon as this summer, and expectations are high. Founders that can figure out now how to harness ChatGPT before it makes the next evolutionary leap come with a built-in promise of a product that will assuredly will get much better.

Talia Goldberg, a partner at Bessemer, which invested in Jasper, said there are three different types within the generative AI space. There's companies like Jasper that use AI models from other companies and make applications for clients. Then there are firms that build those underlying models that power the AI. And finally, there are startups that mix both but focus on providing services for customers.

"We think there will be exciting investments and companies built across all three of those sectors, but we're most focus on the first and last one," Goldberg said. "We want to see companies delivering value to customers."

Erin Price-Wright, a partner at Index Ventures, said AI could evolve into what the cloud and software sectors are now: essential technology used by nearly every modern business.

"We do expect to see the rate of VC dollars going into AI to continue to accelerate," Price-Wright said. "But we don't see AI as an investment category as much as a broader platform shift, like the cloud 10 years ago."

VCs can't help but feeling hopeful

Investors said there's still enough cautiousness in the market that VCs bets will remain small. Tech is in a valuation reset, and VCs believe AI firms, many of which struggle to show revenue, will not be immune.

Section 32 managing partner and CEO Andy Harrison noted that it's easy for investors to look at a technology's potential and invest based on that, but as VCs brace for a difficult year ahead for fundraising, there focus will be on sustainable growth.

"It is possible that a bubble will form around generative AI," Harrison said. "However, a significant bubble is less likely given the current market environment."

VCs plan to spend more judiciously in 2023, even with $290 billion in cash available for investment.

There has also been concern that limited partners — institutions that invest in VC funds — will limit contributions to VCs in the coming years.

While generative AI commands more money and excitement than other sectors like fintech or e-commerce, VCs still want to tread lightly and are speaking about the space with muted optimism.

"There are certainly companies that have raised large rounds, and AI valuations have corrected less than the market more broadly," Price-Wright said. "But some companies will struggle to find the product defensibility needed to grow into their valuations."

Defensibility is a key concern for generative AI startups that rely on OpenAI. Take marketing AI firm Jasper. It uses OpenAI's technology, but makes it much easier to create prompts to get the AI model to spit out usable copy — key for making it accessible to marketing professionals who don't study AI.

But OpenAI is continuously improving and offering more services, and it could eventually learn how to do what Jasper does. Jasper's competitors would then have access to the thing that made Jasper unique in the first place.