The Dark Art of Inflating AI Startup Revenue

Last month, Scott Stevenson, co-founder and CEO of the legal AI startup Spellbook, took to X to expose what he called a "huge scam" among AI startups: the inflation of publicly announced 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 in his tweet.

Stevenson isn't the first to claim that annual recurring revenue (ARR) — a metric historically used to sum up annual revenue of active customers under contract — is being manipulated by some AI companies beyond recognition. Certain aspects of ARR shenanigans have been the subject of multiple other news reports and social media posts. However, Stevenson's tweet seemed to have struck a particular nerve within the AI startup community, drawing over 200 reshares and comments from high-profile investors, many founders, and a few headlines.

"Scott at Spellbook did a great job of highlighting some of what you might describe as bad behavior on the part of some companies," Jack Newton, co-founder and CEO of legal startup Clio, told TechCrunch, adding that the post brought much-needed awareness to the topic, referring to an explanatory post from YC's Garry Tan about proper revenue metrics. TechCrunch spoke with over a dozen founders, investors, and startup finance professionals to assess whether the ARR inflation is as pervasive as Stevenson suggests. Indeed, our sources, many of whom spoke on the condition of anonymity, confirmed that fudged ARR in public declarations is a common occurrence among startups, and how, in many cases, investors are aware of the exaggerations.

The main obfuscation tactic is substituting "contracted ARR," sometimes referred to as "committed ARR" (CARR), and simply calling it 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 is a metric established and trusted since the cloud era to indicate total sales of products where usage, and therefore payments, is metered out over time.

Accountants don't formally audit or sign off on ARR primarily because generally accepted accounting principles (GAAP) focus on historical, already-collected revenue, rather than future revenue. ARR was intended to show the total value of signed-and-sealed sales, typically multiyear contracts. (Today, this concept tends to go by another name: remaining performance obligations.) Meanwhile, the term "revenue" is typically reserved for money already collected.

CARR is supposed to be another way to track growth. But it's a much squishier metric than ARR because it counts revenue from signed customers that aren't onboarded yet. One VC told TechCrunch that he has seen companies where CARR is 70% higher than ARR, even though a significant chunk of that contracted revenue will never actually materialize.