ARR, IRR and other kinds of fraud

It has been equal parts amusing and slightly worrying to see the wide-eyed reactions of many founders at the alleged round-tripping fraud that may have been going on at Builder.ai (I do not know anyone there). I genuinely couldn’t tell whether the tone of some LinkedIn posts was surprise at the fraud or surprise at the fact that this kind of transaction was actually fraudulent in the first place.

On one hand, the startup (or at least venture-backed startup) ecosystem is remarkably high-trust and I’m always surprised that there isn’t more of this kind of thing. Although I suppose the line between stupid allocation of money and fraud maybe isn’t that wide. Nonetheless in the same way that Dan Davies has talked about the optimal level of fraud not being zero, this is a helpful event to open people’s (both investor and founder) eyes to Things Which Can Happen.

On the other hand, this is also an ecosystem which increasingly seems to believe that ARR, an acronym for Annual Recurring Revenue predicated on multi-year contracts that guarantee, you know, annually recurring revenue, is actually the same thing as ‘the revenue we did last month multiplied by twelve’. I’m absolutely willing to accept (and indeed for years pitched) that annually re-occurring revenue is a true category of customer relationship and might even converge with ARR in terms of quality (show me the contracts and let me make some calls), representing an annualised revenue number as ‘ARR’ is pretty fraudy.

Equally I am seeing growing numbers of new investors who get slightly flustered when I ask them why their Internal Rate of Return (IRR) doesn't make sense compared to their projected Multiple of Invested Capital (MOIC). IRR is not a new marketing technique but recently has become a metric of investment performance thrown around with the sort of casual abandon normally reserved for memecoin creation. If you ever want to see a human being physically melt, ask them to whiteboard out how IRRs are actually calculated. There is absolutely a place for IRR in the measurement of performance but don’t confuse it with the cash being returned (or more specifically the timing of the cash being returned).

I’m just saying. Read the contracts, check the bank account, do the maths.