How VCs and Founders Inflate ‘ARR’ to Crown AI Startups

Last month, Scott Stevenson, co-founder and CEO of legal AI startup Spellbook, ignited a firestorm on X by calling out what he described as a “huge scam” among AI startups: the deliberate inflation of publicly reported revenue figures. “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,” he wrote.

Stevenson is not the first to suggest that annual recurring revenue (ARR) , a staple metric meant to capture the yearly revenue from active, contracted customers , is being stretched beyond recognition by some AI companies. Reports and social media posts have previously flagged various forms of ARR manipulation. Yet his post struck a nerve, drawing over 200 reshares and comments from prominent investors, founders, and news outlets.

“Scott at Spellbook did a great job of highlighting some of what you might describe as bad behavior on the part of some companies,” said Jack Newton, co-founder and CEO of legal startup Clio, referencing a related explanatory post from Y Combinator’s Garry Tan about proper revenue metrics. Newton told TechCrunch the post brought much-needed awareness to the issue.

TechCrunch spoke with over a dozen founders, investors, and startup finance professionals to gauge how widespread ARR inflation really is. The consensus, with many sources speaking anonymously, confirmed that fudged ARR in public declarations is common among startups, and that investors are often aware of the exaggerations.

The Core Tactic: Substituting CARR for ARR

The primary obfuscation involves swapping “contracted ARR,” also called “committed ARR” (CARR), and labeling it simply as ARR. “For sure they are reporting CARR” as ARR, one investor said. “When one startup does it in a category, it is hard not to do it yourself just to keep up.”

ARR has been a trusted metric since the cloud era, reflecting total sales from products where payments are spread over time. Accountants do not formally audit ARR because generally accepted accounting principles (GAAP) focus on historical, collected revenue, not future promises. ARR was designed to show the total value of signed, sealed contracts , typically multiyear deals. CARR, by contrast, counts revenue from signed customers who have not yet been onboarded. It is far squishier.

One VC told TechCrunch he has seen companies where CARR is 70% higher than ARR, even though a significant portion of that contracted revenue may never materialize. Bessemer Venture Partners (BVP) wrote 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 noted that startups should adjust CARR for expected customer churn and downsell. The main risk is counting revenue before a product is implemented. If implementation drags on or fails, clients can cancel before paying.

Several investors told TechCrunch they personally know of at least one high-profile enterprise startup that claimed to have surpassed $100 million in ARR, when only a fraction came from paying customers. The rest came from contracts not yet deployed, some of which may take a long time to implement. One former employee at a startup that routinely reported CARR as ARR said the company counted a substantial, yearlong free pilot as ARR. The board, including a VC from a large fund, was aware that the eventual paying part of the contract was counted during the pilot, and that the customer could cancel before paying in full.

The obvious risk of using CARR as ARR is how easily it can be gamed. Without realistic adjustments for churn and downsell, CARR can be inflated. For example, a startup might offer steep discounts for the first two years of a three-year contract and count the entire three years as ARR, even if customers leave before paying the higher year-three price.

“I think Scott is right. I’ve heard all sorts of anecdotes as well,” said Ross McNairn, co-founder and CEO of legal AI startup Wordsmith. “I speak to VCs all the time. They’re like, ‘There are some choppy, choppy standards out.’”

Most cases are less extreme. An employee at another startup described a gap where marketing materials claimed $50 million in ARR, while the actual figure was $42 million. Investors had access to the books showing the lower amount. The source said some startups and investors are comfortable playing fast and loose with public metrics because AI startups are growing so quickly that an $8 million gap is viewed as a rounding error they will grow into.

The Other Problematic ‘ARR’

A separate issue involves another metric sharing the same acronym: annualized run-rate revenue. This ARR extrapolates current revenue over the next 12 months based on a short period’s haul , a quarter, month, week, or even a day. Since many AI companies charge based on usage or outcomes, this method can be misleading because revenue is no longer locked into predictable contracts.

Most people interviewed agreed that ARR overstatements are not new, but they have become far more aggressive amid the AI hype. “The valuations have gotten higher, and so the incentives are stronger to do it,” said Michael Marks, a founding managing partner at Celesta Capital.

In the AI era, startups are expected to grow faster than ever. “Going from 1 to 3 to 9 to 27 is not interesting,” Hemant Taneja, CEO and managing director of General Catalyst, said on the 20VC podcast last September. “You got to go like 1 to 20 to 100.” This pressure to show rapid growth prompts some VCs to support, or at least overlook, startups presenting inflated ARR figures.

“There are definitely VCs in on this because they’re incentivized to create a narrative that they have runaway winners,” Stevenson told TechCrunch. Newton, whose Clio was valued at $5 billion last fall, agreed: “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.”

What VCs Really Think

Other investors say there is no reason for VCs to expose the overstatements. By ignoring inflated public ARR, VCs help kingmake their own portfolio companies. A startup reporting high revenue is more likely to attract top talent and customers who see it as the undisputed category winner. “Investors can’t call it out,” one VC said. “Everyone has a company monetizing CARR as ARR.”

Still, insiders find it hard to believe that some startups reached $100 million in ARR within a few years. “To everyone who’s inside, it just feels fake,” said 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.’”

Not all startups play this game. Some prefer clean, clear numbers, understanding that public markets measure software companies on ARR, not CARR. Wordsmith’s McNairn, recalling the struggle startups faced justifying high valuations after the 2022 market correction, said he avoids exaggerating 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. I think it’s super bad hygiene, and it’s going to come back and bite you.”