TL;DR
Many AI startups are inflating their reported ARR by including contracted but not yet realized revenue, often called CARR, to appear more valuable. Investors are aware but often accept these figures, raising questions about valuation integrity.
Multiple industry sources and a prominent startup CEO have confirmed that many AI startups are inflating their publicly reported annual recurring revenue (ARR) figures by including contracted revenue that has not yet been realized, a practice that could mislead investors and inflate valuations. Learn how inflated ARR impacts startup valuation.
TechCrunch has learned from over a dozen anonymous sources that it is common for AI startups to report ‘contracted ARR’ (CARR) as if it were actual revenue, often without adjusting for potential churn or cancellations. Scott Stevenson, CEO of Spellbook, publicly accused some startups of using dishonest metrics to boost their revenue claims, which has sparked widespread discussion in the startup community. Several investors and founders confirmed that this practice is widespread, with some companies reporting ARR figures significantly inflated by unfulfilled contracts or long-term pilots. For example, one high-profile enterprise AI startup reportedly claimed over $100 million in ARR, but only a small portion of that was from paying customers, with the rest from contracts still in implementation or in pilot phases. Experts note that CARR, which includes signed but not yet operational contracts, is inherently more susceptible to manipulation because it does not always account for customer churn, downsell, or cancellations. See why transparency matters in startup metrics. Some startups have been known to count multi-year contracts with large discounts as full ARR, even if customers might not stick around or pay the full amount. Investors are aware of these discrepancies; one VC told TechCrunch that they have seen companies where CARR exceeds actual ARR by 70%. Despite this, many investors accept inflated figures, viewing rapid growth as justification for higher valuations, even if the underlying metrics are questionable.
Why It Matters
This practice matters because it can distort the true financial health of AI startups, leading to inflated valuations, misallocation of investment, and potential market distortions. Investors relying on inflated ARR metrics risk overpaying for companies that may not deliver the projected revenue or growth. The widespread acceptance of these inflated figures raises concerns about transparency and integrity in startup funding and valuation practices. Read more about how VCs evaluate inflated metrics.
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Background
The use of ARR as a key metric became standard during the cloud computing boom, designed to reflect recurring revenue from signed contracts. Discover the importance of accurate revenue metrics. However, in the AI startup ecosystem, the pressure to showcase rapid growth has led some founders to include contracted revenue not yet realized in their ARR reports. This has coincided with a surge in funding for AI startups, many of which are valued based on these metrics. The practice is not entirely new, but recent public accusations and industry discussions have brought it into sharper focus. Notably, Garry Tan of Y Combinator highlighted the importance of accurate revenue metrics, but enforcement and transparency remain inconsistent. The issue is compounded by the fact that auditors typically do not verify ARR figures, and investors often accept these metrics at face value, especially in a highly competitive, fast-growing sector.
“The reason many AI startups are crushing revenue records is because they are using a dishonest metric. They are inflating ARR with unfulfilled contracts and long-term pilots.”
— Scott Stevenson, CEO of Spellbook
“Scott did a great job highlighting some of the bad behavior in the industry; it’s a much-needed wake-up call for transparency.”
— Jack Newton, CEO of Clio
“We’ve seen companies where CARR is 70% higher than actual ARR, but investors often accept this because growth is so rapid.”
— A VC investor
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What Remains Unclear
It remains unclear how widespread the practice is across the entire AI startup ecosystem, and whether regulators or auditors will take steps to curb inflated metrics. The extent to which investors will continue to accept these figures without stricter verification is also uncertain.
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What’s Next
Industry insiders expect increased scrutiny from investors and possibly regulatory bodies. Future steps may include more rigorous auditing of ARR figures, stricter standards for public disclosures, and greater emphasis on actual revenue versus contracted or projected figures. The debate over revenue measurement practices in the AI sector is likely to intensify.
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Key Questions
What exactly is ARR and why is it important?
ARR, or annual recurring revenue, measures the predictable revenue generated from active customer contracts over a year. It is a key metric used to assess a company’s growth and valuation, especially in SaaS and subscription-based businesses.
What is CARR and how does it differ from ARR?
CARR, or contracted ARR, includes signed but not yet realized revenue from contracts, such as long-term commitments or pilots. Unlike ARR, which reflects actual, realized revenue, CARR can be inflated by including contracts that may not materialize or be canceled.
Why do some startups include unfulfilled contracts in their ARR?
Startups include unfulfilled contracts to present a more impressive growth trajectory, attracting investors and increasing valuation. However, this can be misleading if the contracts do not convert into actual revenue.
Are investors aware of these inflated ARR figures?
Many investors are aware but often accept inflated figures due to the sector’s rapid growth and competitive pressures. Some acknowledge that this practice can distort true valuation but consider it a risk worth taking.
What could happen if regulators or auditors start scrutinizing these metrics more closely?
Stricter oversight could lead to more accurate reporting, potential revaluation of companies, and a push for standardized revenue metrics. This might slow down the current trend of inflating ARR figures and improve transparency in the industry.
Source: TechCrunch
