Unmasking ARR Manipulation in Startups

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0:42With RSS.com, starting your own podcast is free and easy. Upload an episode and we distribute it to Apple Podcasts, Spotify, Amazon Music, and more. Track your listeners, see where they're from, and start earning from ads just like this. If you've been thinking about starting a podcast, this is your sign. Start your new podcast for free today at RSS.com. Welcome back to the podcast. Today, we're talking about how venture capital firms and founders are using something called ARR to kind of inflate their perceived value. Annual recurring revenue, of course, that stands for. But there's a lot of different things that they use to manipulate these numbers based on current revenue, projections in the future, contracts, things like that.

1:31And it's a little bit sneaky. So today we're going to talk about some of these implications when it comes to fundraising, venture capital, things like that. But before we get into all that, I want to tell you about our school community. If you're listening to this and you've always wanted to learn how to actually make money using AI or grow your business, you're going to want to check out our AI Hustle school community. We'll leave a link below. But each week we release bonus content over there, Jaden and I do. and we talk about specific ways we're actually using AI to make money. This week, Jaden and I both walked through different SEO strategies we're using with website building.

2:11We have been deep on vibe coding this year. We talk about AI, music streaming side hustles, all kinds of different topics. But it's really just a great place to be. Right now, you can lock in the price of$19 a month if you join today. and it'll never be raised on you, but really just a great community of like-minded people who are all using AI to build and make money. But let's talk about some of these venture capital startups that are kind of inflating their numbers with the ARR, annual recurring revenue statistic. Jane, what have you heard about this? Okay, this is really interesting. So all of this came last month, Scott Stevenson.

2:52He's the co-founder and CEO of a legal AI startup called Spellbook. And he was actually posting about this on X. So this got a ton of attention and it's very interesting. But he's showing basically how a lot of these venture backed companies are boosting their ARR. I'll show you I'll show you the scam and I'll show you the tweet that he put out on it and how they're essentially using that to manipulate the VCs to give them a ton of money to become the dominant player in their particular industry. So over on X, he said, this is his tweet. He said, it's time to expose a huge scam and AI startups contracted ARR, meaning they have a contract for the ARR, but it's not like they're not actively collecting this.

3:35It's not executed at this price. Anyways, we'll get into it. He said, 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, right? Because everyone likes to say, you know, and I'm not pointing at Suno here, but let's say Suno is making$100 million in annual recurring revenue. XYZ company is making, you know, a billion dollars in annual recurring revenue, whatever, you know, whatever it might be. They say the setup is that a company signs a three-year enterprise deal.

4:09Year one is discounted. So maybe you'll be like, it's a million dollars. Year two is 2 million. And year three is the full$3 million price. They then report$3 million as their annual recurring revenue, even though they've only collected$1 million right now. So they're like, well, the contract on year three, it's making 3 million. So even though we give them a discount now, we're going to like actually count the full revenue because that's, you know, that's what it's going to be. And we have a contract for that, even though the company could cancel with them, could get out of the contract. And so it's, it's basically a very dishonest number.

4:44Um, they say, he said, the worst part is that the customer has an opt out option at 12 months. So it's not actually a 12 year contract. Yeah. That's what I just said. So he then shows a chart, which if If you're watching this on YouTube, you can see. But he said in the chart below by Q5, the company is trumpeting$100 million in annual recurring revenue to press. So telling all the journalists are making that what their actual cash generated, in fact, is 35 million. That's a 3x inflation. He said on top of this, enterprise AI companies are bundling full time forward deployed engineers into deals, massively reducing margins, sometimes producing year one negative margins, meaning you're like, hey, we'll sign a million dollar contract with you and we'll actually send, you know, a hundred of our engineers over to your company to go and make sure that this is our 20 of our engineers over into your company to implement this.

5:35They're called forward deployed engineers, but you're basically, I am paying my like salaried people to go into your company and put my technology into your company. So basically you're getting like free developers. It's kind of a sales tactic to get, to get them in. So really like not only is the contract small and you're inflating it, but you're also spending a ton of money on engineers, which you don't have to report, right? Because if that company had to pay for their own engineers, they're like, look, we're paying for our own engineers to deploy this. We're only going to pay you half that much because of what it costs.

6:07But instead, you're doubling the price of the software subscription and you're just writing it off on your engineers. I think that's a whole nother scam in and of itself if you want to talk about annual recurring revenue metrics sort of scams. Anyways, he then said, at some point, customers are going to start triggering their option out clauses or aggressively negotiating down year three pricing and a wave of enterprise AI companies may collapse. Pretty wild, Jamie, I guess from your from your stance where you're seeing this, what are your thoughts? Yeah, I mean, I think that's that's pretty fascinating.

6:39And I've had that thought before, too, you know, not specifically with this annual recurring revenue idea. But, you know, there's been huge news articles about, you know, OpenAI is going to invest$300 billion in data centers, blah, blah, blah. But that's, you know, you realize that's over 10 years or something. So there's a lot of these big inflated numbers. And the scary part is that you're dealing with your real money and real investors who are hoping to grow their money. And so they're using their confidence in the data to inform their decision, I should say. So if you're basically lying or you're inflating your numbers, it does seem scammish to me.

7:30And then you combine that with all the kind of circular investing we've talked about too, where NVIDIA invests in this company and then that company invests back in NVIDIA. And then they kind of are, you know, their revenue is showing that they're getting this revenue, but they're kind of just investing in each other. I don't know. It's it does seem bubblish to me. And we've talked about this before, but I don't know at what point it crashes or or or what the next steps are. But what are your thoughts, Jaden? Yeah, it's I mean, it's interesting reading through the comments on this thread are really insightful.

8:06There's a lot of VCs commenting here. They're like, I've never invested in anyone doing this. I highly I don't believe like this is actually happening. Like they're like trying to discredit him. There's other people that are like, yep, I see this happening. Someone else, Abishkek Yagi said, there's another scam that is happening offering a$50 a month subscription at$1 for the first month and then you count it as$600 in annual recurring revenue. So, I mean, you can do that. He's like seed 3 ,000 such subscriptions yourself and voila, you've reached$1.8 million in annual recurring revenue in a few days after launch.

8:41The founders are doing this. The founders doing this today are generally the ones who will cook the books later to whatever. It just becomes easier over time. So that's actually another interesting thing that people can do, right? They say like, hey, look, we'll give you a$1 subscription. And I mean, at$1, yeah, like he said, seed$33 ,000. I'm not sure if he's accusing people of literally just making 3 ,000 fake accounts and paying the$1 themselves. So it's cost you three three thousand dollars and then you can go to investors and say look i have 1.8 million dollars in annual recurring revenue because it's gonna be 50 dollars when they renew next month right so right after launch you can have this like huge valuation jump i'm not sure if he's accusing people of doing that or if he's just saying like they can just go for marketing and kind of like find a whole bunch of people to test out their product 3 000 people to test out their product at a dollar either way um it's kind of crazy now i mean as a marketing thing is it bad to give someone a$1 for your first month and then$50 after?

9:37No, I mean, it's basically like a free trial, but you make them pay a little bit of something so that they're already subscribed and on the hook. So as marketing, whatever, I mean, if that's how you want to run your marketing, but I think where it gets shady and becomes kind of sketchy is, well, very sketchy is when you extrapolate the 50K and go to investors and say, this is what our revenue is, and then try to go raise money off of that, which I think people are doing. So anyways, it is pretty wild what's going on in this. There is another comment from Jamoth Polly Hopatia on this thread who said, wow, what company is this?

10:08We only report Gap at 8090. That's his software company. Everything else is crap. Scott says originally heard three to four inside reports at this scale of deception now getting more by DMs. So I guess as he kind of put this out, a ton of people are DMing him about what's going on. Clint Carlos is like, I've never I I have a hard time believing this is happening in any credible circles. If there's a way to cook the books and sort of plausibly say it's legal, I think people are going to do sketchy stuff. So I don't delete that. I don't doubt that's happening. Turner Novak of Banana Capital said, delete this, which is kind of funny.

10:49But anyways, yeah, I believe this is happening. And I think it's hard. A lot of people in the comments are like, is it justifiable? Like they're just figuring out how to play the game. is like all right bro you're probably doing it too huh yeah no all right it's yeah i mean there's it's i think the hard yeah like you said the hard part is when you're you're you're trying to raise money i i also i do have a hard time believing just to play devil's advocate that like a vc firm wouldn't be pick up on that and like realize that that's what they're doing you know like you're supposed they're supposed to do a lot of due diligence and things before they invest in something.

11:24So I could see this being, you know, for a small person who's trying to start like a little SaaS or something on and promote it on Instagram. And maybe they're trying to get some private funding. But I feel like venture capital, that would be pretty surprising to me if they if they fell for that kind of stuff. But I don't know. Yeah, I think what's actually happening here is that the VCs know it in most cases, and they just want to like go to the news and dishonestly say, we just invested in a company that has$100 million in annual recurring revenue. They're going to crush it. And then everyone's like, wow, that company is going to crush it.

12:02And they kind of like are playing the news to try to get bigger headlines and more press coverage and more people to know about, you know, this is the biggest company ever. So I think the VCs, you're right, they do kind of know about it. And they let it happen because they just want the big, the big blast. The last thing I'll say that I have a bone to pick with an anthropic does this all the time. So sorry, Anthropic, but I do not like the term. So we're used to saying ARR, annual recurring revenue, right? Some people that have subscribed for your annual plan or you extrapolate in your 12 months, a monthly recurring revenue, and that's how much you should make in a year.

12:34There is a term they've changed ARR to also mean annual revenue or annual run rate revenue instead of annual recurring revenue. And they still call that ARR. And annual run rate revenue, you can extrapolate from a day or a week. Like there's all sorts of, normally you're, you know, 12X, your monthly recurring revenues, your annual recurring revenue, right? Well, what people are doing is they're like, well, they're like, we're growing so fast that what we made this month and times 12 isn't a good indicator. We have to say what we made yesterday. And yesterday we made$20 million. So times that by 365, that's what our annual, whatever.

13:10Right. So I do not like the run rate, although anthropic, I mean, to be fair, I, threw a lot of shade at them and they really have hit all of their numbers because they've exploded and grown like crazy but every other company doing it is not growing like anthropic so i guess that's the the one case i still don't like the term yeah i mean that's that's interesting like it's kind of like the shark tank theory like even the the businesses that get denied on shark tank they have a terrible business model they if they can get on the show yep they make they their their business kind of blows up. So if you can get the press, if you can get the VC article written, you know, it's kind of like the shark tank thing.

13:48It's the new version of it, I would say. And so people are trying to do that. Lots of different sneaky ways. So anyways, if you got any value out of this episode, be sure to leave us a rating review wherever you're listening. We really appreciate those. We just passed a hundred reviews, which we're super grateful for. We're trying to get to 150. So if you could drop over and leave us some stars, that would be awesome. and then check out our school community if you want to learn how to actually grow your business or make money using AI. Thanks for listening and we'll see you next time.