In recent months, the landscape of artificial intelligence has experienced a remarkable transformation. A surge of start-ups dedicated to creating practical applications based on large language models (LLMs) is not only boosting their sales but also igniting a fierce competition to commercialize these cutting-edge technologies. Investors are increasingly optimistic, banking on companies like Cursor, Perplexity, Synthesia, and ElevenLabs, which are developing innovative apps powered by the robust generative AI models from industry giants like OpenAI, Google, and Anthropic. These start-ups are rapidly gaining traction, with soaring user numbers leading to significant revenue streams.

According to industry insiders, many of these AI-driven enterprises are achieving impressive milestones, with annual recurring revenues (ARR) reaching upwards of $200 million in just a couple of yearsa pace unprecedented in the tech sector. Lorenzo Chiavarini, head of research at Dealroom.co, noted, Many of these start-ups are reaching up to $200mn [in annual recurring revenue] in less than a couple of years, faster than we have seen before, and often with very nimble teams driving strong investor interest. This observation underscores the fervor surrounding AI applications and the eager response from venture capitalists.

In 2024 alone, start-ups focusing on AI-powered applications secured an astonishing $8.2 billion in funding, marking a staggering 110 percent increase compared to the previous year. Data from Dealroom.co and Flashpoint indicates that this funding frenzy highlights the immense potential these companies possess to attract significant investment. For instance, Silicon Valley-based Perplexity, an AI-driven search engine, achieved a remarkable feat by raising $500 million in December, tripling its valuation to $9 billion. Analysts suggest that the company is now on the brink of raising more capital at an even higher valuation.

Another noteworthy player in the AI landscape is Harvey, a legal tech start-up that successfully raised $300 million in February, bolstering investor confidence in the viability of AI applications across various sectors. Miles Grimshaw, a partner at Thrive Capital, emphasized the unprecedented demand for AI applications among businesses and consumers alike, stating, There is real demand for AI applications from real businesses and real people today at a pace that weve never seen before. Thrive Capital, previously an investor in OpenAI, has also backed aspiring app companies, including Harvey and the coding group Anysphere.

The coding sector is witnessing a significant influx of investments, with start-ups like Reflection AI, Poolside, Magic, and Codeium raising substantial capital over the past year. These companies are focused on enhancing the productivity of software developers through innovative solutions. Anysphere, which developed the coding automation tool Cursor, reported raising $105 million at a $2.5 billion valuation, with potential investors expressing willingness to value it at $10 billion or more. The three-year-old start-up is generating annual recurring revenues of about $200 million, reflecting the growing demand for AI-driven coding assistance.

Oskar Schulz, president of Anysphere, pointed out that while natural language processing and English may appear interesting, the true value lies in coding. People think natural language and English are interesting, but they are not immediately valuable. Code really is, he stated, highlighting the focus on software development as a key driver of AI applications.

As valuations in the AI application sector soar, investors remain optimistic that these companies will deliver significant productivity gains in knowledge-intensive and time-consuming tasks. Unlike companies dedicated to developing LLMs, AI app firms do not require the same level of financial investment, making them more attractive to investors. Mike Volpi, an AI-focused venture investor, remarked, Most of these [apps] are productivity tools that create value by combining the natural work that professionals do, especially with each other, and add the AI value to it. This seems to me to create lock-in with their customers.

Victor Riparbelli, CEO of Synthesia, a London-based AI avatar company valued at $2.1 billion earlier this year, echoed this sentiment by stating, Theres increasing consensus that probably most of the value is going to be created on the application layer and not the foundation [model] layer. Recent research corroborates this assertion, indicating that AI start-ups are generating revenue more rapidly than prior waves of software companies, suggesting a promising future for the sector.

An analysis of payment data from fintech group Stripe revealed that leading AI firms are reaching millions in sales within just a year, a timeline considerably shorter than that of comparable non-AI tech companies. The agility of AI app companies enables them to adapt their models whenever a more efficient or cost-effective version emerges. Bret Taylor, chair of OpenAI and co-founder of Sierra, which develops AI customer-service agents, noted, We have changed the models that we use at least five or six times in our short history as a company just because of how rapidly it changes. Taylor likened relying on older models to riding around in a 1950s [car].

However, determining customer loyalty and the sustainability of revenue remains a daunting challenge. The initial excitement surrounding AI often leads to a quick influx of early adopters, resulting in inflated growth rates that may not guarantee long-term subscriptions. Some cautious investors have opted to stay out of the frenzy surrounding these emerging AI app start-ups, expressing concerns that even the most innovative applications may only serve as temporary solutions, or wrappers, built atop existing AI models. This raises the risk that larger corporations with broader customer bases could easily replicate these apps.

Hannah Seal, a partner at Index Ventures, pointed out, Because so many of these companies are new, they havent been through an annual renewal cycle with their customers yet. So you often dont know what the underlying churn numbers are likely to be. Despite this uncertainty, many leading figures in the industry argue that AI has ushered in a new platform shift, paving the way for sustainable businesses, akin to the transformative impacts of the internet, mobile technology, and cloud computing. Taylor encapsulated this sentiment by stating, Theres probably more uncertainty now in the software market than there has been in my entire career.