Scott Stevenson, co-founder and CEO of the legal AI startup Spellbook, recently utilized the social media platform X to expose what he termed a "huge scam" prevalent among AI startups: the public exaggeration of their stated revenue figures.
Stevenson articulated his concern in a tweet, stating, "The reason many AI startups are crushing revenue records is because they are using a dishonest metric. The biggest funds in the world are supporting this and misleading journalists for PR coverage."
While Stevenson is not the first to allege that annual recurring revenue (ARR)—a metric traditionally used to quantify the yearly income from active customers under contract—is being distorted by some AI firms, his remarks resonated particularly strongly. Previous reports and social media discussions have also touched upon various aspects of ARR manipulation.
However, Stevenson's specific tweet ignited a notable reaction within the AI startup ecosystem, garnering over 200 reshares and comments from prominent investors, numerous founders, and even generating several news headlines.
Jack Newton, co-founder and CEO of legal tech company Clio, commented to TechCrunch that "Scott at Spellbook did a great job of highlighting some of what you might describe as bad behavior on the part of some companies." He added that the post significantly raised awareness on the issue, referencing an explanatory article by YC's Garry Tan on appropriate revenue metrics.
TechCrunch subsequently interviewed more than a dozen founders, investors, and startup finance professionals to ascertain the extent of ARR inflation as suggested by Stevenson.
Indeed, these sources, many of whom requested anonymity, corroborated that the public declaration of fudged ARR is a frequent occurrence among startups, and in numerous instances, investors are fully aware of these exaggerations.
The primary tactic for this obfuscation involves substituting "contracted ARR," sometimes referred to as "committed ARR" (CARR), and simply presenting it as ARR.
"For sure they are reporting CARR" as ARR, one investor confirmed, noting the competitive pressure: "When one startup does it in a category, it is hard not to do it yourself just to keep up."
ARR has been a well-established and trusted metric since the advent of cloud computing, designed to represent the total sales value of products where usage and payments are metered over time. Accountants typically do not formally audit or approve ARR because generally accepted accounting principles (GAAP) primarily focus on historical, already-collected revenue, rather than future projections.
The original intent of ARR was to display the total value of finalized sales, typically encompassing multiyear contracts. (This concept is now often referred to as remaining performance obligations.) In contrast, the term "revenue" is generally reserved for funds that have already been received.
CARR is intended as an additional method to track growth. However, it is a considerably less precise metric than ARR because it includes revenue from signed customers who have not yet been onboarded or begun utilizing the service.
One venture capitalist informed TechCrunch that they have observed companies where CARR figures were 70% higher than their actual ARR, despite a substantial portion of that contracted revenue being unlikely to ever materialize.
Bessemer Venture Partners (BVP) outlined in a 2021 blog post that CARR "builds on the ARR concept by adding committed but not yet live contract values to total ARR." Crucially, BVP emphasized that startups are expected to adjust CARR to account for anticipated customer churn (customers leaving) and "downsell" (customers reducing their service level).
The fundamental issue with CARR arises from counting revenue before a startup's product has been fully implemented. If the implementation process is protracted or encounters difficulties, clients may cancel during the trial period before any—or even all—of the contracted revenue has been collected.
Several investors disclosed to TechCrunch that they are directly aware of at least one high-profile enterprise startup that publicly reported exceeding $100 million in ARR, when only a fraction of that income originated from currently paying customers. The remainder stemmed from contracts that had not yet been deployed, with technology implementation potentially requiring significant time in some cases.
A former employee of a startup that habitually reported CARR as ARR revealed to TechCrunch that the company even included a substantial, yearlong free pilot program in its ARR figures. This individual stated that the company's board, which included a VC from a major fund, was aware that revenue from the eventual paying portion of the contract had been counted in ARR during the extended pilot. The board also knew that the customer retained the option to cancel before fulfilling the full contract amount.
The inherent problem with using CARR and presenting it as ARR is its heightened susceptibility to being "gamed" compared to traditional ARR. Without realistic accounting for churn and downsell, CARR can be significantly inflated. For example, a startup might offer substantial discounts for the initial two years of a three-year contract and count the entire three years as CARR (or ARR), even if customers are unlikely to remain once higher prices are introduced in the third year.
"I think Scott [Stevenson] is right. I’ve heard all sorts of anecdotes as well," Ross McNairn, co-founder and CEO of legal AI startup Wordsmith, told TechCrunch regarding ARR misrepresentations. "I speak to VCs all the time. They’re like, ‘There are some choppy, choppy standards out.’"
Most cases, however, are slightly less extreme. For instance, an employee at another startup described a discrepancy where marketing materials claimed $50 million in ARR, while the actual audited figure was $42 million.
This source asserted that investors had access to the company's financial records, which accurately reflected the lower amount. The individual suggested that some startups and their investors are comfortable with a degree of looseness in their public metrics, partly because the rapid growth of AI startups means an $8 million gap is often perceived as a minor rounding error that will quickly be overcome through growth.
Another issue surrounds these public ARR declarations: some founders use a different measurement that shares the "ARR" acronym and a similar name: annualized run-rate revenue.
This version of ARR is also contentious because it extrapolates current revenue over the next 12 months based on a short-term period's earnings (e.g., a quarter, month, week, or even a single day).
Given that many AI companies charge based on usage or outcomes, this method of calculating annualized run-rate ARR can be misleading because revenue is no longer secured by predictable, long-term contracts.
Most individuals interviewed for this story acknowledged that overstatements of ARR, in various forms, are hardly a new phenomenon, but they noted that startups have become considerably more aggressive in their reporting amidst the intense AI hype.
"The valuations have gotten higher, and so the incentives are stronger to do it," Michael Marks, a founding managing partner at Celesta Capital, explained to TechCrunch.
In the current AI era, startups are under pressure to demonstrate significantly faster growth than ever before.
"Going from 1 to 3 to 9 to 27 is not interesting," Hemant Taneja, CEO and managing director of General Catalyst, commented on the 20VC podcast last September, referring to the traditional multimillion-dollar ARR projections for startups. "You got to go like 1 to 20 to 100."
This intense pressure to exhibit rapid growth is leading some venture capitalists to support, or at least overlook, startups that present inflated ARR figures to the public.
"There are definitely VCs in on this because they’re incentivized to create a narrative that they have runaway winners. They’re incentivized to get press coverage for their companies," Stevenson told TechCrunch.
Newton, whose legal AI startup Clio was valued at $5 billion last autumn, also alleges that VCs are often aware of ARR misrepresentations but choose to remain silent. "We see some investors looking the other way when their own companies are inflating numbers because it makes them look good from the outside in," he shared with TechCrunch.
Other investors who spoke with TechCrunch contend that there is no compelling reason for VCs to publicly expose these overstatements.
By tacitly accepting public pronouncements of inflated ARR, VCs are effectively helping to "kingmake" their own portfolio companies. A startup that publicly reports high revenue is more likely to attract top talent and customers who perceive the company as the undisputed leader in its category.
"Investors can’t call it out," one VC stated to TechCrunch. "Everyone has a company monetizing CARR as ARR."
Despite this, anyone intimately familiar with the industry's complexities finds it difficult to believe that some of these startups genuinely achieved $100 million in ARR within just a few years of their launch.
"To everyone who’s inside, it just feels fake," remarked Alex Cohen, co-founder and CEO of health AI startup Hello Patient. "You read the headlines and you’re like, ‘I don’t believe it.’"
However, not all startups are comfortable representing their growth by reporting CARR instead of ARR. These founders prioritize transparency, preferring to be clear and precise about their figures, partly because they understand that public markets evaluate software companies based on ARR rather than CARR.
Wordsmith’s McNairn, recalling the challenges startups faced in justifying high valuations after the 2022 market correction, emphasized his reluctance to create an even greater hurdle by exaggerating his startup's revenue.
"I think it is short-sighted, and I think that when you do things like that for a short-term gain, you’re overinflating already crazy high multiples," he asserted. "I think it’s super bad hygiene, and it’s going to come back and bite you."
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