Y Combinator Tells Founders ‘Be Truthful’ On Revenue

Garry Tan, the CEO of legendary investor Y Combinator, has waded into the ARR debate over how startups represent their revenues, and demanded that ‘founders be precise, and always be truthful’.

He has published on X a paper titled ‘Being Truthful And Precise About Revenue’, where he sets out in a sort of ‘Finance for Startups 101’ several key ways that companies can report their growth accurately, (see below).

Tan states: ‘Here’s YC’s official advice…. about what is pilot, bookings, revenue and recurring revenue. Founders, particularly first-time founders, need to sear this into their brains. Don’t mistake one tier for another. Be precise, and always be truthful.’

Y Combinator is an investor in hundreds of startups – including Legora – and also runs its own incubator, which has launched the careers of many successful company founders. If the market in general begins to doubt the veracity of key reported metrics, such as ARR (annual recurring revenue) – which is often broadcast to the world in order to encourage new investment, attract top talent (e.g. by the promise of increasingly valuable share options), and to gain potential customers by generating headlines – then, to put it simply, faith is eroded. And all markets need trust to function.

A fundamental problem is that ARR is not an officially defined accounting term, so startups and their CFOs can – if they want to – fudge the numbers to look more successful than they are. Or, this can simply happen unintentionally because founders are unclear on how to define ARR, or other key revenue terms. Hence Tan, who leads the prominent Y Combinator, felt the need to step in. Plus, the misuse of ARR metrics could potentially reflect poorly on investors as well.

The debate was brought to the attention of the legal tech world after Scott Stevenson of Spellbook claimed that he knew of startups that were, in his view, misrepresenting their actual revenues to the market. Artificial Lawyer shared his views – see here – and afterward the responses from a range of legal AI companies – see here – on how they approach ARR.

Below is Tan’s paper on how to use revenue terms correctly.

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‘Being Truthful And Precise About Revenue‘ – Garry Tan, CEO, Y Combinator

‘In descending order of least impressive to most impressive, all of these are different metrics and you should not confuse them, nor mislead investors representing one as the other:

• LOI – Non-binding Letters of Intent (LOI) (e.g. a customer signed a document where they would be willing to pay $100K for this if our product is built and works in the future, but there is no guarantee of payment and only an indication they will be a pilot customer in the future).
  • You could say: We have $100K in non-binding LOIs from customer X, Y and Z.
• GMV – For marketplaces or retailers: Gross Merchandise Value (GMV) or Gross Services Revenue (GSR) is your “top line” transaction volume, and it is a mistake to call this your “revenue.” In a marketplace, your revenue is typically GMV multiplied by your take rate (the percentage of each transaction you keep).
  • Rule of thumb: GMV is the money flowing through the system; marketplace revenue is your slice (GMV multiplied by your % take rate). Don’t call GMV ‘revenue.’
  • You could say: Our GMV this month is $100k with a take rate of 20%, so our marketplace revenue is $20K monthly.
• cARR – Bookings / cARR: A customer has signed a contract that specifies they will pay $X per year or per month. This is more solid than an LOI, but not all bookings are equal: pilots, opt-out clauses, or ‘starts billing after deployment’ reduce how strong it is.
  • You could say: We have $100K in contracted ARR (cARR) from customers X, Y, and Z, mostly in pilots that start billing once we’re fully deployed.
• Transactional revenue over a particular time period (e.g. monthly revenue multiplied by 12 — we sold $50K of the product this month, and if that continues for the whole year, that’s $600K annualized revenue). Note: You should never call this ARR, as it is not recurring.
  • You could say: We make $50K per month in transactional revenue. OR We make about $600K in annual revenue run rate.
  • Note: Annual Revenue Run Rate is never abbreviated to ARR, per next point.
• MMR or ARR – [Monthly or Annual] Recurring Revenue (e.g. Revenue actually invoiced and paid on a regular basis, per contract renewed monthly or yearly) – this is the most impressive and most prized form of revenue, and only then would you use the prized MRR or ARR metric.
  • You could say: We make $50K MRR (monthly recurring revenue).’

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As with the articles in Artificial Lawyer about ARR, Tan’s missive to the market received lots of support, but also saw a surprisingly notable group of people who thought that misleading information was not a problem.

AL doesn’t want to keep repeating the point, but this site has to say: if we cannot trust the financial data put out by legal tech companies, or startups in any other vertical, then it harms the entire market – and also casts doubt on the investors in those companies as well. Plus, it potentially causes harm in terms of falsely attracting talent and new customers, not to mention it misleads the media and other market observers. Plus, one could say, if you start your company in that way, what will it be like as it matures toward an IPO? It seems to be storing up a range of issues that could later become highly problematic, to say the least.

As mentioned here before, the answer is not complicated: pick a metric, define it, stick to it.

Here is the Garry Tan post on X.

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