Brian Nichols is the co-founder of Angel Squad, a community where you’ll learn how to angel invest and get a chance to invest as little as $1k into Hustle Fund's top performing early-stage startups.

If you're building a SaaS company and you don't know your ARR, you're basically flying blind. But here's the dirty secret: tons of founders calculate it incorrectly, and some are deliberately inflating their numbers.

Let's fix that.

What ARR Actually Measures

Annual Recurring Revenue is the annualized value of your subscription contracts. It tells investors how much predictable revenue your business will generate over the next year, assuming zero growth and zero churn (which, let's be honest, never actually happens).

The basic formula is simple: take your Monthly Recurring Revenue (MRR) and multiply by 12. Or if you have annual contracts, add up the recurring value of all those contracts normalized to a one-year period.

Here's what counts:

• Subscription revenue from annual or multi-year contracts
• Recurring add-ons, upgrades, and expansion revenue
• Revenue from renewals

Here's what doesn't count:

• One-time setup fees
• Professional services revenue
• Training fees
• Hardware sales
• Non-recurring discounts or promotions

The key word is "recurring." If a customer pays you once and that's it, it's not ARR.

Why Everyone Loves (And Manipulates) This Metric

ARR became the gold standard during the SaaS boom because it's a clean proxy for business health. Investors can quickly assess traction, growth trajectory, and the predictability of your revenue stream. A company with $5 million in ARR growing 3x year-over-year is way more interesting than one with $5 million in revenue that's all from one-time projects.

But as AI startups flooded the market and valuations skyrocketed, something shifted. Suddenly, founders started counting all sorts of weird things as ARR. Pilot programs that might convert to subscriptions? ARR. Letters of intent? ARR. Someone expressed vague interest at a conference? Probably ARR.

I'm exaggerating, but only slightly.

The pressure to show traction early has led to some creative accounting. The problem is that this undermines what made ARR useful in the first place: predictability. If your "recurring" revenue is actually a bunch of maybe-if-everything-goes-right revenue, it's not recurring at all.

Common Mistakes Founders Make

Here's where people screw up the calculation:

1. Taking a single great month and multiplying by 12. This is the MRR-times-12 trap. If you just landed your first enterprise customer and your MRR spiked from $10K to $50K, you can't claim $600K ARR. That spike isn't representative of your normal run rate. SaaS businesses have seasonality and volatility, especially early on.
   
   
2. Including non-recurring revenue. Setup fees don't count. Training doesn't count. If a customer pays you $100K for annual subscription plus $20K for implementation, your ARR from that customer is $100K, not $120K.
   
   
3. Counting unsigned contracts. If you haven't signed the paperwork and received payment (or at least have a legally binding contract), it's not ARR. Hope is not a strategy, and it's definitely not revenue.
   
   
4. Ignoring churn. ARR should account for lost customers and downgrades. If you added $500K in new ARR but churned $200K, your net new ARR is $300K. Don't bury the churn.

ARR and Retention: The Critical Pairing

Here's something that doesn't get talked about enough: ARR alone is meaningless without context. You need to pair it with retention metrics.

I once invested in a company that grew from $8K quarterly revenue to $46K quarterly in nine months. Six times growth, incredible, right? But when we dug into the retention data, customers were churning fast. The ARR growth masked a fundamental problem: the product wasn't sticky enough.

The retention issue often comes down to customer segment. Small businesses churn more than enterprises. If you're selling to SMBs, expect higher churn. If that's your market, you need to account for it in your growth projections and probably charge more upfront to make the unit economics work.

How to Increase ARR (Without Gaming It)

There are legitimate ways to grow your ARR:

1. Acquire more customers. Obvious, but worth stating. The more paying subscribers you have, the higher your ARR.
   
   
2. Increase average revenue per account (ARPA). Upsell existing customers. Add premium features. Raise prices for new customers (carefully).
   
   
3. Reduce churn. Fix the product issues that cause people to leave. Improve onboarding. Make your product stickier.
   
   
4. Expand into higher-paying customer segments. If you started selling to small businesses, maybe it's time to target mid-market or enterprise.

The key is solving real problems. Customers pay for value. If your product legitimately helps them make money or save time, you can charge more and they'll stick around longer.

The Investor Perspective

When I look at a company's ARR, I'm asking a few questions:

Is this number real? Have they actually signed contracts and collected money?

What's the retention like? Are customers sticking around or churning fast?

How efficient is their customer acquisition? What does it cost them to add $1 of ARR?

What's the growth trajectory? Are they doubling every year? Tripling?

ARR is a starting point, not the full story. It needs to be combined with other metrics—customer acquisition cost, lifetime value, gross margin, burn rate—to understand whether the business is actually healthy.

But if you're a founder and you get the ARR calculation wrong, or if you inflate it with sketchy accounting, smart investors will figure it out during diligence. And once they lose trust in your numbers, you've probably lost the deal.

Play it straight. Calculate ARR correctly. Be honest about what's working and what isn't. The goal isn't to maximize your ARR number for a pitch deck. The goal is to build a business that actually generates recurring revenue predictably.

If you're working on building a SaaS business and want to connect with investors who understand these metrics inside and out, Angel Squad brings together founders and investors who've navigated these challenges successfully and can help you avoid the common pitfalls.