Spellbook CEO calls out 'CARRGATE': how AI companies are inflating ARR by 3–5x with contracted revenue tricks

Speaker 9: Doing great. Doing great. How are you guys?

Speaker 1: We're good. Welcome to the show. How are you doing?

Speaker 9: Good. Good. Yeah. Thanks for having me.

Speaker 1: Can you I I mean, I wanna go into the contracted IRR debate, but let's get the update on Spellbook. How are things going? Where's the company at? How are you feeling?

Speaker 9: Going very well. We had a killer q one. Crushed our our stretch targets last year. Yeah. We're over 4,400 customers on board in 80 countries now.

Speaker 1: 80 countries?

Speaker 9: Yeah. We're the the the most used AI contract review tool in the world.

Speaker 1: So Why so international so early?

Speaker 9: It's been inbound. Yeah. We we've had a ton of interest inbound. So, yeah, it it really you know, the choice is accept the customers or turn them away. Yeah. You know, we chose to accept them. Yeah.

Speaker 1: Is the product sort of multilingual by default?

Speaker 9: I would say yes. Like, a lot of it is driven by AI models. AI models have some ability to deal with diff actually, good ability to deal with different languages. Yeah. And then we're able to supplement the models with legislation and norms from many different jurisdictions since we're a legal product.

Speaker 1: Yeah. So, yeah, where where else are the key integration points? Like, what's the hard work to, like, bring a country on board or even bring a new flow on board or expand the capabilities of the product as models are just sort of getting better every month by default in the background?

Speaker 9: Yeah. I mean, I think for us, the the bit you know, we try to be two years ahead of the market and and and build things that are two years ahead of what anyone else is building in legal AI or elsewhere, and we've consistently done that. We've built the very first Gen AI product for lawyers back in the 2022. This is like before ChatGPT. Wow. So a lot of, like, clod for word just came out. Yeah. That was kind of what we launched like four years ago. So we're pretty pretty far ahead from that now. What we really focus on is building unique workflows that are not just chat. I think if you're building something chat shaped, it's very difficult to make that defensible because there's going to be some really good general AI products for just generic chat based based work. What we focus on at Spellbook is really rails for high volumes of contracts and contract workflows. So we sell to, like, Fortune 10, Fortune 100 companies, and really companies of all sizes who are processing, you know, hundreds of thousands of contracts, not just with the legal team but with their sales team, their procurement team. Sure. We're in manufacturing, shipping, all of these different verticals. We kind of build these end to end rails that allow these contracts to

Speaker 1: move

Speaker 9: quickly and safely through organizations. Like, there's a lot that can slip through the cracks when you're dealing with these high volumes of contracts. A lot of mistakes are made. So, you know, we give, like, every legal team a second set of eyes on, like, these massive flows of contracts going through the organization.

Speaker 2: Yeah. What drew you to Cargate? Why other is it is it legal AI companies that you that you feel like are are getting a little bit dicey on this front or or, you know

Speaker 8: Yeah. I mean

Speaker 2: How how how do we get here?

Speaker 9: Yeah. So I've I've got some interesting examples to cite, but, you know, I think I think it's an enterprise AI problem. I'll say I'll say first, like, my goal here with this tweet and and what I'm doing is is to destroy as much equity value as possible by did by Sounds like discrediting this obscene metric of CARR Yeah. Or at least the way it's being used today. So we can all get back to, like, building real companies. So that's that's that's what I'm trying to get out there. Sure. Mean, where this came from is I think I just noticed more and more founders and investors telling me things about ARR reporting, mainly the public reporting, but also some of the internal reporting Mhmm. That was just getting more and more skewed. Mhmm. And, yeah, there's all these headlines being published about, you know, ARR records being broken.

Speaker 1: Sure.

Speaker 9: And, you know, when the laws of physics are being broken, you have to ask, is it is it AI breaking the laws of physics or, you know, might there be some other kind of illusion going on as well? And I think I think it's a bit of both. We have really high growth, awesome companies being built. But when you have really high growth, you know, issues can kind of fester and hide underneath. So, yeah, I'd heard a lot of more and more stories of people using this metric of CERR, often using this metric when they're talking to press about, you know, revenue and then gaming it in some pretty pretty obscene ways. So And maybe I

Speaker 1: just tweeted about it.

Speaker 2: Yeah. The the tweet. So Yeah. You say the setup. Company signs three year enterprise deals. Year one is discounted, say 1,000,000. Year two steps up 2,000,000. Year three is full price. They report 3,000,000 as ARR even though they're only collecting $1,000,000

Speaker 1: a big deal.

Speaker 2: Yeah. The worst part, the customer has an opt out option at twelve months. It's not actually a three year contract. So they're basically like taking the three year number, pulling it into the present even though it's not a it's not Yeah. It's a contract that that the customer can can get out of. Interesting. And they're not actually on on the hook. So it's not really

Speaker 1: It's rough. We so so Yeah. Yeah. Yeah. You just react to that, I guess.

Speaker 9: Yeah. So I think I think, you know, that's a specific real example that I I heard of in the wild from an from an insider of how this this these error metrics were being gamed to create, you know, some some amazing revenue charts. But I would say there's, you know, a broad category of issues that I can talk about, like a few of them that, you know, after the tweet went viral. I got a huge response of other founders and investors saying that they were saying the same thing and like some other examples of the types of gaming that's going on.

Speaker 2: Yeah. Because because focus of the donuts. You get one person in a category that starts doing this, then then the other people

Speaker 9: We have to report

Speaker 1: the have same

Speaker 2: to start reporting the same way and it creates a vicious cycle.

Speaker 9: Yeah. And it start and it starts pretty innocent, you know. C ARR for folks that don't know, C ARR is contracted ARR. So it allows you to count revenue that's not live yet. So maybe you're doing like a nine month implementation or you have a one year pilot.

Speaker 2: For short short term stuff. Like, hey, this this this contract is going you know, this this customer is actually gonna be going live next quarter

Speaker 1: Mhmm.

Speaker 2: But we've signed it and we're just going Got through the implementation process. Yeah. Yeah. And but but yeah. There's nothing that there's no, like, law that says you can't say, like, we're gonna extend the the sort of, like, timeline dramatically. Mhmm. It just is not a very grounded way to run your business.

Speaker 9: Mhmm. Exactly. Exactly. Yeah. And, like, I think it's innocent. Like, three months extra credit, you know, arguably useful, but it's a very easy metric to gain, especially if you miss those obligations. So I think because we we kind of normalize, you know, the forward deployed engineer, which,

Speaker 1: you know, we used

Speaker 9: to call professional services. And so now you have these really complex implementations where you might be promising a customer like, hey, we'll build this feature. And once we build this feature, then we'll start billing you. What happens if you don't build that feature? So one of the issues you see is companies stacking all these commitments of they'll switch on billing once they deliver x with their forward deployed engineers. Then what happens if they miss that or what happens if that gets delayed? They that and then they're reporting it upfront as ARR publicly, but they're not actually at the point where they're the ARR is is live. So, yeah, that's another category of issue. And then there's, you know, people reporting pilots, you know, just three month pilots as ARR and they're free free pilots. That you know, I I was talking to an investor yesterday who just sees that all the time from early stage companies, like, coming out of accelerators saying they have, a million ARR, and they look under the hood, and it's just all pilots that haven't converted yet. So there's a host of different, you know, issues with the metric. And then and then the other one is the step up contract where, yeah, you're stepping up, you know, year one is, you know, 25% of the cost, year two is a little higher, year three is higher. And then people are either amortizing that back over the period to get a higher average or even taking, like, that year three amount, like you said at the beginning. So, yeah, there's a bunch of patterns that are happening. The other thing is, like, there's early opt outs. So, like, you know, you can have early opt outs in these long term contracts. And but there's all I mean, we're a contract company, so there's a million ways that a contract can be

Speaker 2: terminated for a Seen a few contracts.

Speaker 9: Yeah. Yeah. Yeah. So Yeah. What yeah.

Speaker 1: I think

Speaker 9: I think it's it's a really ungrounded metric, and people should stop using it to report their enterprise AI companies should stop using it to report their ARR publicly. I think no one should take it seriously except maybe internally for some projections. You know, it's it's not a not a good good metric.

Speaker 1: What is the gold star example of using ARR correctly? Because it's very easy once the company is public to just say, okay. Let's just go off of, you know, GAAP revenue for the year and, like, what did you actually book this quarter? There's a whole revenue recognition policy. It feels like there's some benefit to tracking ARR month by month if you're a high growth startup. But what is

Speaker 2: Overrated best companies should just report their daily annualized run rate

Speaker 1: or Yeah. And then and that goes to the debate of annualized versus annual. Right? So how have you processed sort of the better cases? Like, what is the responsible way to report a revenue metric in 2026?

Speaker 9: Yeah. I mean, I think it depends on the company and the shape of the company and whether it's usage based billing or seat based billing, which you still have lots lots of both. Definitely don't do, like, hourly, you know, annualized run rate based on the on the hour. Yeah. That's not good. I think the the main thing I would say is it should be live. It's like what revenue is actually live right now for like, what customers are you actually billing and are actually paying you? So calculating run rate based on, the month of revenue that you have coming from customers that are actually paying you that you're actually billing, I think that's okay. Annual recurring revenue based on live customers that you're actually billing, that are actually using your service, I think that's pretty good. I think once you start stretching into people who will pay you or, you know, might pay you, that's where things start to I mean, it can just be so easily gamed and anything that can be gamed will be gamed.

Speaker 2: Yeah. Yeah. Mean Are you optimistic that anything will change or do we need to see a massive correction and and a dark and a dark the dark ages, like I mean post 2022?

Speaker 9: I I mean, I would like to see a a steep correction and then back back to back to building. You know? We'll see if we can make that happen. You know? My reach is only so far, but, you know, I I I've had I've spoken to a lot of reporters in the past, like, forty eight hours who are like, I'm always going to ask now. Like, when the company tells me their ARR, are they talking live error? Are they talking, you know, this, like, long term committed ARR that might come? So I hope, you know, at least the journalists are gonna be a little little bit more a little bit more savvy and ask ask more questions before they report on these numbers.

Speaker 1: Yeah. The I wanna ask about who suffers, but in terms of ARR, like, yeah, there's almost something where you should just report your last month's revenue instead of doing the times 12 thing. And then if people wanna multiply it by 12, they can, but at least you're just reporting, hey, last month, this is what the Stripe account did.

Speaker 2: You can also just say by q three, we will be at x ARR. Mhmm. Or Exactly. Because that's different way of saying that's that's better than saying we are we are at 10,000,000 Yeah. C a r. Yeah. Yeah. So

Speaker 9: Exactly. Much better.

Speaker 1: Who who suffers here? Is it is it purely investors? Because I feel like a good venture capitalist, their job is to dig into the contracts during due diligence to set prices. And if they want to pay, you know, a thousand times ARR because they think it's a 100 times CARR, like, that's their risk profile. Like, I would maybe be careful, but, you know, that's their job. Or is there a risk that employees see a headline number and think that the business is more stable than it is and they join and then they're rugged? Like, how do you think this affects the who needs to watch out for this, basically?

Speaker 9: Yeah. I mean, I think I think investors are generally good investors are generally very aware of the difference between CER and ARR and aware of the the widening gap between these metrics. And, like, in most board decks, you see two metrics. On the press, you only you know, you usually see CRR, but it's called ARR.

Speaker 1: Yep.

Speaker 9: In in a board deck, you see both metrics. So Yep. So, you know, investors are quite aware, but but I I I don't think it's victimless at all. I think, yeah, employees are signing up for companies. As you know, in in, like, a a high growth startup, people are committing a ton of blood and sweat to be successful Yeah. Based on you know, part of it is based on the growth of their equity. And if it turn and they might think they're they're they're multiple you know, they might read the headline number. May they may not know the number that's actually in the board deck. They might read the head the headline, you know, ARR in in the in the press release, and they might base base their decision to join a company Totally. Based on these headline revenue numbers, which are really not grounded in reality whatsoever. Like and by that, I mean, I have literal examples, confirmed examples of, you know, the the press number being three to five times higher than the actual live ARR number. So, like, that's a huge difference if you think about a multiple Yeah. Yeah. Yeah.

Speaker 1: Between a public company that's trading at 10 x revenue multiple or something, and then you get your you get your offer from a company and it seems like they're at 10 x, but they're actually at 50 x. Like, that is very material how you should think about valuing that that stock that you're waiting for. Makes a ton of sense.

Speaker 9: Then there's the customers. Like, customers are trying to figure out which company is most mature or least mature, and then there's the, you know, like, the the whole competitive landscape. It's like if one person if one company starts doing this, all companies have to start doing it and it just creates Yeah.

Speaker 2: Mean, we can start doing contracted viewership. So we've signed three year deals I

Speaker 9: love it.

Speaker 2: People in the audience that requires them to tune in to Do

Speaker 1: the the show every show. Every year.

Speaker 2: They have an opt out after a month

Speaker 1: Yeah. Yep.

Speaker 2: If they don't like it after a month.

Speaker 9: Still advertising based on contracted viewership contract

Speaker 4: for the rest of year.

Speaker 9: Watch every day, every hour.

Speaker 1: I mean I mean, I I guess that sort of does happen for YouTube channels that, I mean no one really does this but there was a time when YouTube channels were sort of valued on like the subscriber number as opposed to the average view number. And of course there are some channels where every video gets a a million views and they only have a 100,000 subscribers for whatever reason. And then there's vice versa where someone's been doing you see this on, like, old legacy media accounts on x where they'll have, 30,000,000 followers. And then the post will get, like, three likes. And it's like, those are two wildly different metrics. Like, that happens all the time. But this is the name this is the name of the game in Silicon Valley, the metrics game. Everyone's finding an edge somewhere. Well, thanks for keeping everyone honest and good reporting. Good luck fighting the good fight out there spreading the good word.

Speaker 2: Don't don't don't get too sucked into all this. You're

Speaker 1: You got a business to build, you know?

Speaker 2: Can take

Speaker 8: I'm building

Speaker 2: back on. Promise you can come back on in three years Yep. With your with your honest ARR and take a good victory lap.

Speaker 1: No. No. Become an investigative journalist. Pivot to investigative journalism. Blow those doors wide open on this.

Speaker 2: Wow. This goes deeper than I thought. Yeah. Good to good to see you.