TL;DR
Many AI startups are inflating their ‘ARR’ figures by including contracted but not yet realized revenue, often through ‘committed ARR’ (CARR). Investors and founders acknowledge this practice, which can mislead stakeholders about actual revenue and growth. This raises questions about transparency and valuation practices in the AI sector.
Multiple sources confirm that a significant number of AI startups are inflating their annual recurring revenue (ARR) figures by including contracted but not yet realized revenue, often referred to as ‘committed ARR’ (CARR). This practice is supported by some investors and has drawn criticism for potentially misleading stakeholders about the true financial health and growth prospects of these companies.
Sources within the startup and investment community, including investors and founders, acknowledge that inflating ARR through the inclusion of CARR is common among AI startups seeking to demonstrate rapid growth. Learn more about this approach. CARR accounts for revenue from signed contracts that have not yet been implemented or paid, making it a more flexible but less reliable metric than traditional ARR, which reflects revenue already recognized and collected.
TechCrunch has learned that some startups report CARR figures that are significantly higher than their actual ARR, with one example citing a discrepancy where reported ARR was $50 million, but actual revenue from paying customers was closer to $42 million. Investors are aware of these practices but often accept them due to the fast growth and competitive pressure within the AI sector. Some companies have even counted long-term pilots or contracts with uncertain fulfillment as part of their ARR, raising concerns about the accuracy of these metrics.
Why It Matters
This practice matters because inflated ARR figures can distort investor perceptions, inflate company valuations, and mislead stakeholders about the true financial health of AI startups. As venture capital funding continues to flow into AI, the use of potentially misleading metrics risks creating a bubble and undermining trust in startup reporting standards.
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Background
The use of ARR as a key metric became widespread during the cloud computing era, intended to measure recurring revenue from signed contracts. However, the rise of AI startups has coincided with a tendency to include contracted revenue not yet realized, often without rigorous adjustments for churn or downsell. Industry discussions, including a recent tweet from Scott Stevenson of Spellbook, have brought attention to this issue, highlighting concerns over transparency and the potential for abuse. Read more about related industry concerns.
“The reason many AI startups are crushing revenue records is because they are using a dishonest metric. They are inflating ARR by including contracted revenue that isn’t yet realized.”
— Scott Stevenson, CEO of Spellbook
“Scott did a good job highlighting some of the bad behavior around revenue metrics. It’s important to bring awareness to this issue.”
— Jack Newton, CEO of Clio
“We’ve seen companies where CARR is 70% higher than actual ARR, even though a lot of that contracted revenue may never materialize.”
— A VC investor (anonymized)
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What Remains Unclear
It remains unclear how widespread this practice is across the entire AI startup ecosystem, and whether regulatory or industry-led efforts will lead to stricter standards. The extent to which investors rely on these inflated metrics for decision-making is also not fully known. Find out more about investor reliance.
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What’s Next
Industry stakeholders, including investors and standard-setting bodies, may introduce clearer guidelines or audits to verify revenue claims. Further disclosures and transparency measures could emerge as the practice gains scrutiny, potentially impacting startup valuations and funding dynamics. Explore related transparency issues.
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Key Questions
What is ‘ARR’ and how is it supposed to be measured?
ARR, or annual recurring revenue, is a metric that measures the predictable, recurring revenue a company expects annually from current customers, based on signed contracts that are already implemented and paying.
Why are some startups including contracted revenue in their ARR figures?
Startups include contracted revenue not yet realized, often called ‘committed ARR’ or ‘CARR,’ to showcase higher growth and attract investment, even if that revenue has not yet been collected or may never materialize.
Are investors aware of these inflated metrics?
Many investors are aware of the practice and sometimes accept it due to the rapid growth and competitive pressures within the AI industry, though some acknowledge it can be misleading.
Could this practice lead to a bubble or market instability?
Yes, if inflated metrics significantly distort valuations, it could contribute to a market bubble, especially if actual revenue and growth do not meet the reported figures.
Source: TechCrunch
