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Keith MacKay
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The Letter VCs Are Quietly Deleting from ARR

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The Letter VCs Are Quietly Deleting from ARR

Startups are reporting revenue they haven't earned yet. VCs know it. Investors are cheering anyway. We've seen this movie.

You're evaluating an AI startup. The pitch deck shows $100 million in ARR. The growth curve is parabolic. The deck says they signed $100 million. What it doesn't say is that $70 million of that is "committed ARR": contracts signed but not yet invoiced, customers who haven't deployed yet, pilots that count toward the number if they convert. Subtract the gap and you've got $30 million in actual recognized revenue hiding under a $100 million headline.

This is the ARR inflation playbook, and it's running at full speed right now.

The Trick Has a Name

"CARR" stands for Contracted or Committed ARR. It's a legitimate concept. In industries where revenue accrues slowly after contract signing (healthcare AI deployments, energy optimization platforms, multi-year enterprise integrations), the gap between signature and recognition can legitimately take months or years to close. Reporting CARR alongside ARR, properly labeled, is defensible.

That's not what's happening.

What's happening is simpler: founders strip the "C" and just call it ARR. One VC told TechCrunch the gap between CARR and actual ARR can run as high as 70% [1]. In some confirmed cases the spread is 3-5x. Another investor said flatly: "For sure they are reporting CARR as ARR" [1]. The article indicates that the investor community is not only aware, but many are actively complicit.

The logic follows its own warped rationality. When one startup in a category inflates, the others have to follow to stay competitive for talent and headlines. "When one startup does it in a category, it is hard not to do it yourself just to keep up," as one investor put it [1]. Spellbook CEO Scott Stevenson, one of the few willing to call this in public, described the practice as a "huge scam," adding that major VC funds are not just watching it happen but actively supporting the narrative [2].

The metric isn't tracking business reality. It's tracking a story being told for the benefit of people who need the story to be true.

We Have Seen This Before

If you were in the SaaS world circa 2021-2022, this will feel familiar.

At the peak of the zero-interest-rate era, growth-at-all-costs was the gospel. Companies reported "ARR" using definitions that would have made their accountants wince: annualizing a single good month, counting trials, counting LOIs, counting anything that could be plausibly labeled recurring. The metric became a narrative tool, not a financial one.

The crash was instructive. When rates rose and growth-multiple valuations compressed, the distance between reported metrics and cash reality became unforgiving. Companies that had raised at 40x ARR on inflated numbers found themselves underwater fast. The write-downs from venture portfolios in 2022 and 2023 were staggering.

Go back further to the dot-com era and the dynamic is even starker. Eyeballs. Page views. Registered users. Each bubble generates its own vanity metric that sounds like a financial number but behaves like a PR number. The AI cycle's version is CARR-as-ARR: precise enough to sound real, slippery enough to hide the gap.

The pattern is always the same: a new category, a new metric, and a crowd of people with aligned incentives telling themselves the old rules don't apply.

Why This Is Actually a Ponzi Problem

Run the actual math. An AI startup raises at, say, 20x its reported $100 million ARR. Valuation: $2 billion. But if actual ARR is $30 million, the real multiple is 67x: a number most rational investors wouldn't accept if they saw it plainly. The gap has to close in one of two ways: either the revenue materializes (the CARR converts, the contracts activate, the pilots become paid customers) or the next fundraise arrives before anyone asks hard questions.

The next round keeps the story alive. The round after that does too. The round after that is either an IPO, an acquisition, or a reckoning.

When markets are liquid and multiples are expanding, the gap can stay hidden indefinitely. The new money funds the old story. But when the music stops (rising rates, a public market correction, a category reset), the companies sitting on inflated ARR find themselves without chairs.

The investors who got in early will have returned their funds by the time the reckoning arrives. The investors who got in at round D or E on a $2 billion valuation backed by $30 million in real revenue will not. The employees who took lower salaries for equity will not.

This is not hyperbole. This is the documented playbook of every prior cycle, replayed with different vocabulary.

What to Actually Look At

If you're evaluating AI companies (as an investor, an acquirer, a PE firm doing diligence, or a potential enterprise customer checking vendor stability), here's what the ARR number won't tell you:

Cash in the bank and burn rate. If a company has $100 million in ARR and $40 million in cash with a $6 million monthly burn, the story is different than if they're sitting on $200 million. ARR doesn't pay rent. Cash does.

Revenue recognition policy. What accounting standard are they using? When do they book revenue: at contract signing, at deployment, at invoice, at collection? A company that recognizes revenue at signature on multi-year contracts is telling a very different story than one that recognizes monthly on delivery. This requires asking directly. The answer tells you which ARR definition you're working with.

Customer concentration. "100 million in ARR" is a very different number if three customers represent 60% of it. Realization risk and churn risk are both concentrated.

Logo churn vs. dollar churn. The churned customer count understates dollar exposure. The customer who leaves quietly is rarely the small one.

Pilot-to-paid conversion rate. AI adoption timelines are long. Pilots run 90 to 180 days. Not all convert. CARR that depends on pilot conversions is optimistic by nature. Ask for the historical conversion rate, not the projected one.

  • How much of the CARR has a contractual obligation (signed MSA with SOW) versus a letter of intent?
  • What's the average time between contract signing and first invoice?
  • What percentage of contracts have renewal clauses versus auto-renew?
  • Has any CARR been written down or reclassified in the last 12 months?

The gap between CARR and ARR, over time, is the most diagnostic number in the cap table. If it's not shrinking, the story isn't working.

The Bigger Issue: What It Does to the Category

ARR inflation isn't just a valuation problem. It distorts the entire category.

When inflated numbers become the benchmark, every founder in the space has to match them or look like a laggard. Genuine companies with honest metrics get compared to fictional ones. Investment dollars flow toward the best story rather than the best business. Talent follows the valuation. The whole category gets mispriced.

And then, when the reckoning arrives, it hits every company in the category, including the ones that were never inflating anything. The SaaS crash of 2022-2023 punished honest operators alongside the embellishers. The AI category will be no different.

The valuation you benefit from on the way up is the same one that drowns you on the way down.

The people who understand this are the ones currently doing the quiet work of building real revenue from paying customers. They're less interesting at cocktail parties right now. They'll be a lot more interesting in 18 months.

The Bottom Line

AI ARR inflation is widespread, VC-tolerated, and structurally identical to every prior cycle's vanity metric problem. The gap between contracted and recognized revenue is real, the incentives to obscure it are powerful, and the investors most exposed are the ones entering late on valuations built on stories rather than cash. That pitch deck you looked at (the one with the parabolic curve and the $100 million headline): the real number is in the footnotes. Ask for the footnotes.

What's your experience on this? Are you seeing CARR-as-ARR in the market, and how are you adjusting your diligence process?

References

  1. How VCs and founders use inflated 'ARR' to crown AI startups — TechCrunch, May 22, 2026
  2. AI startups are inflating a key revenue metric to win VC attention, says this founder — Fast Company

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Keith MacKay is a technology strategy consultant and CTO in EY-Parthenon's Software Strategy Group (SSG), specializing in AI disruption and technology diligence for private equity and corporate clients. SSG's AI Disruption Lab conducts rapid assessments of how AI transforms and threatens existing business models and value chains. Keith teaches at Northeastern University and writes about strategy, management, and AI/technology, with Claude Code and Codex as AI collaborators.

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