The ARR Mirage

When AI-powered digital workforce platform 11x raised $50 million at a $350 million valuation from venture capital firms Andreessen Horowitz and Benchmark, the US-based startup proudly touted nearly $10 million in annual recurring revenue (ARR). 

Months later, however, investigations by TechCrunch revealed that the actual ARR was closer to $3 million. The company, critics alleged, had been counting short-term trial customers of three months as if they were locked into full-year contracts. 

While 11x disputed the findings of the investigation, this fiasco brought to light a deeper problem plaguing startup finance. 

ARR, once a straightforward measure of contractual commitments, has morphed into an ambiguous and, at times, manipulated metric in venture capital. 

As AI companies race to demonstrate explosive growth, the gap between reported ARR and business reality has never been wider. 

In this scenario, founders often lean on extrapolation—the blind spot in this story—taking a single month’s revenue and multiplying it by 12. 

True ARR represents contractual certainty—customers who have committed to paying for a whole year or more. Annualised revenue or ARR, in contrast, is mere mathematical wishful thinking, assuming that one month’s performance will repeat itself 12 times. 

When ARR is Meaningful and When It Isn’t 

Consider the mathematics: a startup that earns $100,000 in July can legitimately claim $1.2 million in annualised revenue. 

“When we hear someone say, ‘I have annualised $1.2 million of revenue’, versus a founder that says ‘I have $1.2 million in ARR’, I know immediately that the founder with $1.2 million annualised revenue does not have a 12-month contract,” Jay Krishnan, head of investments of India at Beyond Next Ventures, said in an interview with AIM. 

“The likelihood that an early founder has an ARR is reasonably slim,” he added. 

The confusion is not limited to terminology. Joseph Johnson, founder of LedgerUp, told AIM, “Folks often include pilots or one-time fees in ARR, not because they mean to mislead investors, but just because they're confused on what ARR is."

Johnson added that it is also challenging for founders in a heavy-usage-based business to share ARR and thus end up sharing the annualised revenue.

Besides, even when used correctly, ARR may fail to paint the whole picture. A startup could boast seemingly high recurring revenue, yet still operate at a supremely high net loss if acquiring a single customer incurs a high cost.

Complicating matters further, founders often interpret ARR differently. “Founders want to calculate ARR in lots of different ways, and everyone treats it slightly uniquely,” Johnson said. Founders, especially in the software-as-a-service (SaaS) sector, face a fair bit of mathematical challenge while calculating ARR. 

In the traditional mathematical sense, monthly recurring revenue (MRR) is simply multiplied by 12 to obtain ARR. 

However, Krishnan explained how startups can encounter a challenge. He said that if a company signs new customers in different months, each with its own monthly recurring revenue, the contracts are staggered over time. “You can’t just sum up all three clients.” 

When customers finish their monthly contractual obligation and do not resume, multiplying MRR by 12 cannot yield ARR. 

Moreover, AI startups are using tokens, compute time, the number of queries, and more to bill customers. “And these tend to go up or down based on utilisation, because even the clients are trying to figure out how to best use AI,” he added. 

Over the last few months, ARR has been in the spotlight in some of the biggest startup growth stories. Yet, when calculated correctly, ARR is a good way to see the predictability and legacy of both customers and business, Krishnan argues. This is probably why it remains one of the most widely used metrics. 

But annualised revenue cannot be dismissed entirely either. For a startup that is only two months old and reports annualised revenue of 1.2 million, it still matters. “Because in two months, he or she is able to crack 100k of revenue, and they’ve used the word annualised to project forward. So it has to be taken in context,” said Krishnan. 

If Not ARR, Then What? 

For investors seeking genuine signals amid the ARR noise, Krishnan advocates for a more comprehensive approach to evaluating startup health. Rather than fixating on revenue metrics alone, he emphasises looking at multiple characteristics to reveal a business's true trajectory. 

Tracking the progression from bookings to billing to revenue is equally important. Startups typically have a business development team driving bookings, a finance team handling collections, and then does it translate into revenue. If this sequence forms a consistent funnel, it signals growth.

Customer retention, however, may be the single most telling metric. “Net revenue retention is a great metric because it shows upsell opportunity, which means that the customer is using the product and wants to use it more,” Johnson emphasised. “It’s dangerous when someone signs a large enterprise that has an AI budget but does not actually use the product enough,” he warned against superficial enterprise deals.

Krishnan pointed to gross revenue retention and net revenue retention as essential metrics, but reserved special attention for churn, which refers to the rate at which customers stop doing business with an entity.

In SaaS, churn rate, which is the percentage of customers who leave over time, is a critical retention metric. A low churn rate indicates a strong product-market fit, while a high churn rate suggests that customers don’t find lasting value. Unlike acquisition numbers, which can be inflated, churn reveals whether growth is sustainable.

For measuring customer engagement, he suggested examining daily-to-monthly active user ratios, feature adherence rates and time spent in the product. “The more you launch features, and the more the customer adheres to it, as opposed to launching features but nobody using them, that's a good way to measure engagement.”

Additionally, the efficiency metrics that matter most are centred on unit economics. Krishnan highlighted the “golden ratio” of lifetime value to customer acquisition cost at 3:1. This ratio means that the company earns three times more from a customer than it spends to acquire them, indicating a sustainable business model. 

That said, measuring metrics requires discipline from founders and investors, including clear definitions, honest reporting, and a focus on business fundamentals that ARR signifies. 

Only then can it accurately measure genuine, sustainable growth, rather than hiding accounting tricks.