a16z VC wants founders to stop focusing on crazy ARR numbers

The AI ​​investment boom (or perhaps bubble) is something Silicon Valley has seen many times before: a gold rush of venture capital money thrown into the Big New Thing. But one aspect of it is quite unique in these times: startups whose annual recurring revenues go from $0 to as much as $100 million, sometimes in a matter of months.

Word on the street is that many VCs won’t even look at a startup that’s not on the high road ARR, aiming for $100 million in ARR before a Series A funding round.

But Jennifer Lee, general partner of Andreessen Horowitz, who helps oversee many of the company’s top AI businesses, warns that some of the ARR obsession is based on myths.

“Not all average rates of return are equal, and not all growth is equal either,” he told me on an episode of TechCrunch’s Equity podcast. She said she was particularly skeptical of a founder announcing eye-popping ARR numbers or growth in a tweet.

Now, there’s a legitimate and well-known term in accounting called annual recurring revenue, which refers to the annual value of contracted recurring subscription revenue. Essentially, this is a guaranteed level of revenue because it comes from customers under contract.

But what many of these founders tweet about is actually their “revenue run rate” – taking any money paid in a certain period of time and turning it into an annual amount. This is not the same.

“There’s a lot of missing nuance in business quality, retention, and durability that’s missing in that conversation,” Lee warned.

The founder may have had a great month of sales, but that doesn’t necessarily happen every month. Or a startup may have a lot of short-term customers doing pilot programs, so revenue isn’t guaranteed to continue beyond the trial period.

Normally, such tweet growth boasts should be taken for what they are – i.e. don’t take everything you read on the internet at face value.

But since rapid growth is the hallmark of AI startups, such claims “cause a lot of anxiety” for inexperienced founders who are now wondering how they too can instantly go from zero to $100 million, she said.

Lee’s answer: “Don’t do it. Sure, it’s a great ambition, but you don’t have to build a business that way, just to optimize revenue growth.”

The best way to think about it, she said, is how to grow sustainably, so that once customers sign up, they stick around and expand their spending with your company. This could lead to “5- or 10-fold year-on-year growth,” Lee said, meaning growth from $1 million to between $5 million and $10 million in the first year, to between $25 million and $50 million in the second year, and so on.

These levels of growth are still “unprecedented,” Lee noted. If that’s coupled with happy customers — i.e., high retention rates — these startups will find investors willing to back them.

Of course, some companies under the Li a16z group (the infrastructure team) have achieved these kind of ARR racing numbers: Cursor, ElevenLabs, and Fal.ai. This growth is linked to “strong companies,” Lee said, adding that “there are real reasons behind each of them.”

Lee also said that this kind of growth comes with a host of operational issues such as staffing.

“How do we hire the right people, not quickly, but who can really jump into that kind of speed and culture,” she said. The answer is: not easily.

This means that the first 100 people wear many hats and mistakes are bound to happen. Last year, Cursor, for example, angered its customer base by badly changing prices.

Lee noted that other fast-growing startups are dealing with legal and compliance issues before they have systems in place or facing new problems in the age of artificial intelligence such as combating deepfakes.

So, while rapid growth can be a good problem to have, it’s also a case of “be careful what you wish for.”

Listen to the full episode here: