E435: Why Most Companies Aren’t Ready for AI

David Weisburd (0:00)

What does it mean for a company to have a moat in a post-AI world?

SC Moatti (0:04)

We mapped 550 companies in the Seven Power Framework, and we mapped them by defensibility of their moat, and by how much money they have raised. When you're asking, how do you get a moat in AI, it's not just about the moat, it's also about the value that you can generate for your investors. The surprises we saw were two things. One is, you'd expect that the more money you raise, the more so you'd be on a kind of a diagonal line. Only OpenAI and Tropic are on that diagonal, and they are the very top of the diagonal. So raise the ton of money, really defensible. Then there's a cluster of companies that have raised a ton of money, but aren't defensible, because they rely on moats that no longer work in AI, like switching costs, or even cornered resources like a data moat.

And then there's also a cluster of companies that have raised very little, because they're super capital efficient, because they're leveraging AI.

And they're super valuable because they rely on two moats, one being network effects, which is saying, how do you make your product more valuable as people use it? And then the second one is a different kind of moat, which is counter positioning, which is the traditional moat you see when you have a platform shift and you say, I'm going to do the same thing but differently. And so the moats that work in AI are completely different than the moat that worked in the SaaS era of switching cost and a data moat. It's really network effect and counter positioning.

David Weisburd (1:36)

How do you stay disciplined in terms of valuation in a time like today?

SC Moatti (1:42)

It's easier than you think. We target very specifically serial entrepreneurs who are building a capital efficient company that grows fast and is fairly valued. You'll be surprised how many serial entrepreneurs want to raise less. You read in the headlines they raise these massive rounds, but the reality is what's exciting and challenging for many of them is to maximize the use of AI, which essentially means be incredibly capital efficient. You read about these three person companies.

You'll find that a lot of serial entrepreneurs, they want to minimize their dilution to maximize their outcome, and therefore, they're quite reasonable on valuations. The other thing that we're noticing is that these serial entrepreneurs, the calculus they make is the AI platform shift is going to be a long one. It's going to be like 10, 15 years. They have a choice to make, which they have to make earlier and earlier now, which is do I start now and go all the way and in 10 years, I may get to an IPO knowing that there are fewer and fewer IPOs, or do I go out, exit quickly and then do it again and I can do it three times, and I'll probably make more money this way than if I aim for the IPO.

David Weisburd (2:59)

The IPO market has gone smaller and smaller. I just had the former PM at Teal Macro, Peter Teal's hedge fund, and he said that as more money goes into the pass of indexing, that's taking away from the active managers, and the active managers are the ones underwriting IPOs, which is why it's harder and harder to pass that threshold of being a public company.

SC Moatti (3:21)

That's one of the factors. The other factor is what's happening in the research division of the investment banks, where they have essentially a limited pool of resources, and they're deciding who are we going to cover, which ticker. And they're obviously going from the top and down. And so what that does is if you go public with a small market cap, you're not going to get covered by analysts, and therefore your ticker is not going to be actively traded, and therefore your stock is not going to appreciate. Even like right now, the IPOs, we celebrated our sixth IPO a few months ago, Netscope. It went public for $10 billion.

Our first IPO was Amplitude. It went public for $5 billion, and so did Digital Ocean. So the market has shifted to $10 billion and up, but even $10 billion is still a low floor, and so folks who want to go IPO, they need to generate maybe more like $30, $50 billion worth of value before they consider an IPO. Being a public company CEO is difficult because of Sarbin Zoxley. You compare that to an M&A or licensing deal like GROK, right? NVIDIA licensed GROK for $20 billion. That was our most recent exit. Well, $20 billion is a pretty nice outcome, and it's an M&A, so there's a lot less hassle to deal with.