Liar's Valuation
What early employees should know before signing
We have models solving International Math Olympiad problems, AI writing production code, diagnosing diseases, passing the bar.
Yet CEOs of the best startups still can’t tell bookings from revenue from ARR at first glance. Neither can most GPs at venture funds. The journalists covering these companies are building headlines too fast to *actually* ask.
Last week, a friend asked me about their offer to a hot AI company’s $10B valuation. They had no idea what that number actually meant, how the round was structured, what the lead investor really paid. They saw the headline and assumed their equity was valuable.
It’s 2021 again. And 2015 again. Same games, same victims, just different buzzwords.
Before I go further: this post is about understanding what you’re signing up for, not about whether you should sign up. Some of the best career decisions are financially irrational. You might join a company because you believe in the mission, because the team is exceptional, because you’ll learn things you can’t learn anywhere else. I’ve made those choices myself.
But even irrational decisions deserve clear eyes. Your time is the only asset you can’t make more of. You should know what you’re trading it for.
If you’re new to startups and terms like “409A” or “strike price” or “fully diluted” sound foreign, I put together a primer on startup equity that covers the basics. Read that first, then come back here for how those mechanics get manipulated.
Part 1: Revenue
Let’s start with definitions because most people, including many investors, use these terms interchangeably when they mean completely different things.
Bookings are promises. A customer signs a contract saying they’ll pay you $120,000 over three years. You’ve “booked” $120,000. But you haven’t collected it yet. They might pay monthly. They might churn in year two. The booking is a commitment, not cash in hand. Revenue recognition and cash flow are not the same thing, nor do they have to be.
Revenue is what you’ve actually earned. Under accounting rules, you recognize revenue as you deliver the service. That $120,000 three-year contract becomes $40,000 per year, recognized as you provide the product.
ARR is Annual Recurring Revenue, and it used to mean something specific. Subscription revenue that repeats. A customer paying $1,000 per month represents $12,000 in ARR. The word “recurring” was the whole point. It implied the revenue would continue because the customer was subscribed, not because they were making one-off purchases.
Investors paid high multiples for real ARR because the future was predictable. A company with $10M ARR, 90% retention, and 75% gross margins might be worth 15-20x that revenue. The subscription persists. Customers expand over time. You can model it.
That definition is now dead.
The new formula: take last month’s revenue, multiply by 12, call it ARR.
Doesn’t matter if it’s transactional revenue. Doesn’t matter if margins are 15%. Doesn’t matter if customers buy once and never return. Multiply by 12, call it ARR, and suddenly you’re being compared to Salesforce. In egregious cases, doesn’t matter if it’s marketplace pass-through or GMV.
Transaction businesses now call themselves ARR companies.
Think about a full body MRI scan company. You pay $3,000 for a scan. You get one scan. Maybe you’ll get another in three years if you’re diligent about preventive health. There’s no subscription. Nothing recurring about it. It’s a transaction, like buying a car.
But if that company did $5M in scans last month, they’ll report “$60M ARR.” One prominent VC firm’s annual letter called a diagnostic imaging company an “ARR company.” This blew my mind. These are healthcare services businesses with margins around 20% and no built-in retention mechanics. Public market multiples for businesses like this are 2-4x revenue, not the 15-20x that software companies command.
By calling it ARR, they get compared to software companies. They claim “fastest to $100M ARR.” They raise at software multiples while running completely different economics.
Data labeling companies do this. Marketplaces taking a cut of transactions do this.
Finance companies with transaction revenue do this too.
Some of the hottest fintech companies report massive ARR numbers. Dig into the composition and 80-90% of that “ARR” is transaction revenue from card swipes and payment processing. Not subscriptions. Not recurring in any meaningful sense.
If customers swipe less next month, the “ARR” drops. When recession hits and spending declines, this “ARR” craters. One well-known fintech’s engineering blog celebrated hitting “$100M ARR” (you know the chart, “Years from $1M to $100M”) when the vast majority was interchange and transaction fees. Different risk profile. Different business model. Different appropriate multiple. On top of that, they compared annualized revenue run rate to annualized recurring revenue as if they were the same thing.
Hybrid models are even messier.
A vibe coding platform sells you a seat for $20 per month. That’s subscription revenue. You also pay for usage: tokens, compute, API calls. That’s consumption revenue. These two types of revenue have completely different economics, but companies blend them together.
Here’s the math. Say a company has 1,000 customers paying $20 per month for seats. That’s $20,000 in monthly subscription revenue, or $240,000 annually. Those same customers collectively spend $200,000 per month on usage, which is $2.4M annually. Total annual revenue is $2.64M.
The company reports “$2.6M ARR” as a single number.
But the subscription piece and the usage piece are fundamentally different. The subscription revenue is predictable with decent margins and probably good retention. The usage revenue swings wildly month to month, and margins are often brutal because you’re paying OpenAI or Anthropic for API calls and marking them up 20%.
Blending them into one ARR number hides everything important. A business that’s 90% usage-based gets compared to a business that’s 90% subscription-based as if they’re equivalent. They’re not.
Creative counting is the worst offender.
Free trials counted as ARR by assuming they’ll all convert. They won’t.
Monthly customers multiplied by 12 as “ARR” even though they signed month-to-month because they’re not sure about the product yet. That’s not annual recurring revenue. That’s monthly-maybe-recurring revenue.
Pilots counted as ARR before conversion. Verbal commitments treated as signed contracts. “Pipeline ARR” presented as if it were actual revenue.
I’ve seen all of these from companies that raised real money from sophisticated investors.
What this means for your equity:
When a company tells you they’re at “$50M ARR” and growing 3x year over year, they’re using that number to justify their valuation. That valuation justifies your equity grant. Your equity grant is supposed to justify the risk you’re taking by joining.
But that $50M might actually be $30M in low-margin transactions that won’t repeat, $15M in usage revenue that swings 40% month over month, and $5M in actual recurring subscriptions.
The company presents one number. The economics underneath are three completely different businesses. Your equity is priced off the headline, not the reality.
Questions to ask before joining:
Always follow the money. Cash flow. What’s coming in from customers and what’s going out.
For traditional subscription companies: What percentage is annual contracts versus monthly? What’s net revenue retention? Are existing customers spending more over time or less? It should be over 100% for healthy software businesses. What’s gross margin?
For hybrid companies: Can you break out subscription versus usage revenue? How exactly is ARR calculated? What are margins by revenue type? What does retention look like in 12-month cohorts, not 3-month cohorts?
Most companies won’t share all of this. That tells you something. The ones confident in their numbers will explain because they’re proud of them.
At every startup I joined, I sat with whoever handled finance and refused to sign until I understood the real economics. Not paranoia. My time is worth more than optimistic storytelling.
Part 2: Valuation
Public companies have one price. Everyone buys and sells at the same number. You can disagree with whether the multiple is justified, but you can’t dispute what the price actually is.
Private markets don’t work this way anymore.
How it’s supposed to work:
A company raises a seed round. $3M at a $15M valuation cap. Every investor, whether it’s the lead fund, the angels, or the operators writing small checks, participates at the same terms.
A company raises a Series A. $10M at a $50M post-money valuation. The lead writes $8M, others fill in $2M. Everyone pays the same price per share.
Your equity grant is based on that valuation. Your strike price reflects that price. Everyone’s playing the same game with the same numbers.
How it actually works in 2025:
Tiered rounds where different investors pay wildly different prices, but only the highest price gets announced.
Venture funds have ownership targets. They need to own a meaningful percentage of winners to generate returns. At seed, a fund might want 15-20% ownership. At Series A, 15-20%. At growth stages, 10-15%. These targets are non-negotiable for serious funds because ownership drives returns.
So here’s the problem. A company wants to raise $10M at a $1B valuation. That’s 1% ownership. No serious lead investor will write that check. The ownership is too small. The board seat isn’t worth it.
But founders want the billion-dollar valuation. It’s a recruiting tool. A press headline. Signals momentum.
So they structure tiered rounds.
The lead investor puts $50M at a $500M valuation. They get their 10% ownership. The economics work for them. They did the diligence. They negotiated the terms. They decided what the company was actually worth.
Then the company opens a second tranche at a $1B cap. FOMO investors pile in. Tourists who want to say they own a piece of a “unicorn.” Funds that missed the earlier allocation. Angels who don’t care about ownership targets because they’re writing small checks anyway.
Press release goes out: “Company raises $80M at $1B valuation.”
The lead paid $500M. The tourists paid $1B. A 2x spread depending on when you showed up.
Your 409A valuation, which determines your strike price, which determines what you pay to exercise your options, lands somewhere in that range. Usually closer to the headline than to what the smart money actually paid.
Let me walk through why this hurts you.
Companies want to show a large total comp. Salary plus equity per year, the biggest number possible to compete with everyone else. It’s a vicious cycle.
$250K/yr salary plus $500K/yr equity and they get to email you an offer letter saying $750K/yr total comp.
The headline number from a press article flows to an internal blogpost flows to your offer.
Company raises two tranches. Tranche A is $50M at $500M post-money. That’s the lead investor. Tranche B is $25M at $1B post-money. That’s everyone else.
The lead investor owns 10% at $500M valuation. They did the real diligence. They set the terms. They decided $500M was the right price.
Your 409A comes in at $700M, somewhere between the two prices. Your option grant is 10,000 shares at a $7.00 strike price.
Now here’s the problem. For your options to be worth real money, the company needs to exit well above $700M. But the most sophisticated investor in the deal valued it at $500M. You’re already paying a 40% premium over what smart money thought it was worth.
If the company exits at $600M, the lead investor makes money. They paid $500M. You lose money because your strike price was $7.00 and the exit price might be $6.00 per share. Same outcome, different results, because you bought at different prices.
Growth rate is the only thing that matters at high multiples.
Here’s where I need to be honest. Some of these valuations will look cheap in hindsight.
In 2021, some software companies traded at 50-100x revenue. People called it a bubble. Those multiples crashed 70-80%.
In 2025, AI companies are raising at 200-500x revenue. People call it visionary.
OpenAI felt absurdly overvalued at $10B. It’s now worth 50x that. A company growing 4x annually will outrun almost any valuation if that growth sustains. The math that looks insane today becomes obvious in retrospect.
Growth rate is the only variable that matters at these multiples. Not the current revenue. Not the current multiple. The growth rate.
But here’s the question you should actually ask: How many months of perfect execution do you think this company needs to grow into this valuation?
A company with $2M revenue raising at $1B valuation is trading at 500x. For that to become a reasonable 10x multiple, they need to hit $100M in revenue. If they’re growing 3x annually, that’s about three years of flawless execution. No stumbles. No market shifts. No competition eating their lunch. Three years where everything goes right.
What’s the probability of three years of perfect execution? Now you’re asking the right question.
Most companies at 500x multiples won’t grow into them. Some will grow past them. The ones that do will make everyone who dismissed them look stupid.
When evaluating a high-multiple company, focus on the runway to reasonableness. What’s the month-over-month growth? What does the pipeline look like? How are cohorts retaining and expanding? How many months of perfect execution before this multiple makes sense? If the answer is 18 months and you believe in the team, maybe. If the answer is five years, you’re buying a lottery ticket.
How to spot tiered rounds:
When you see a valuation that seems disconnected from reality and the round size seems small relative to that valuation, it was almost certainly tiered. A good litmus test is 10% ownership.
$50M raised at a $1B valuation. That’s 5% ownership. No lead fund would accept that. The round was structured with multiple prices.
If you see a $10B valuation for a company with $30M ARR, that’s 333x revenue. Either someone’s lost their mind or there are multiple tranches baked in.
Questions to ask about your equity:
About the round structure: Was it raised at a single price or in tranches? What did the lead pay versus other participants? What percentage of the round came in at the headline valuation?
About your negotiating position: Given valuation risk, can I get more shares? Can I take more cash and less equity? Is early exercise available?
About your specific grant: What’s the current 409A valuation? What’s my strike price? What’s my grant as a percentage of fully diluted shares, including all options and warrants, not just shares outstanding?
The company may not answer all of these. Watch how they react when you ask. Defensiveness tells you more than the answers would.
Part 3: This Keeps Happening
2000: Revenue recognition games. Companies booked revenue they’d never collect. Round-trip transactions inflated sales. Employees held options through the crash and watched them go to zero.
2008: CDOs sliced into tranches with different risk profiles. The sophisticated players understood exactly what they were buying. Goldman knew the CDOs were garbage. They packaged them anyway, sold them to German banks and pension funds, then shorted the same products. When the music stopped, Goldman had already exited. The German banks held the bag. Complexity wasn’t a bug. It was the feature that let insiders profit while outsiders got destroyed. Everyone else held AAA-rated securities that turned out to be worthless.
Nobody went to jail. The game continued.
2021: “ARR” that included free trials, pilots, verbal commitments. Valuations at 100x revenue justified by zero interest rates. When rates rose, the music stopped. Public multiples crashed 70-80%. Private markdowns followed.
Employees who joined at peak valuations watched their equity evaporate. Some had exercised their options at high strike prices, owed taxes on paper gains through Alternative Minimum Tax, and then watched the stock become worthless. They owed the IRS money on gains that no longer existed and couldn’t afford to pay because the shares they’d bought were now worth nothing. That’s not an abstract risk. I know people this happened to.
The founders made their choices and live with the consequences. The investors had diversified portfolios across dozens of companies. Some won, some lost, the portfolio survived. The employees had concentrated positions in single companies and often no understanding of what they’d actually bought.
2025: Different year, identical playbook.
Companies report “ARR” that isn’t recurring. Valuations at 200-500x revenue. Tiered rounds where headlines diverge from reality. Journalists report the numbers without asking what they mean.
I’m not worried about investors. Their portfolios diversify. They’ll be fine.
I’m not worried about founders. They made their choices. They’re adults.
I’m worried about the engineer comparing offers who thinks ARR means ARR. The designer joining a “unicorn” who doesn’t know the round was tiered. The PM taking equity over cash because the multiple seemed reasonable based on numbers constructed to mislead.
These are the people who get hurt every cycle. They keep getting hurt because nobody explains how the game actually works.
What To Actually Do
First, decide why you’re joining.
If you’re joining to learn, to break into an industry, to work with people who will make you better, to build something you believe in: those are valid reasons that have nothing to do with financial math. Some of the best career decisions are economically irrational. I’ve made them myself. The learning and relationships from my startup years were worth more than any equity outcome.
But even irrational decisions deserve understanding. Know what you’re signing up for. Know what the equity is probably worth. Then make the choice with clear eyes.
If financial outcome matters to you, do the work. Scratch that. Always do the work. It’s your time.
Ask the questions from this post. Watch how the company reacts. The best companies will explain their numbers because their numbers are real. They’ll walk you through how ARR is calculated. They’ll explain the round structure. They’re proud of their metrics because the metrics reflect a genuine business.
Companies playing games will deflect. They’ll tell you it’s “not standard” to share that information. They’ll reframe your questions. They’ll make you feel like you’re being difficult for asking.
That reaction is your answer.
Weight cash appropriately. If the equity is speculative, with high multiples, unclear revenue quality, and tiered round structures, weight cash more heavily in your decision. Cash is liquid. Cash is real. You can pay rent with cash. You can invest cash in index funds. You know exactly what cash is worth.
Run the math yourself. A $1B valuation with 10,000 shares out of 100M fully diluted means you own 0.01%. For that equity to be worth $1M without dilution, the company needs to exit at $10B. What’s the probability of a $10B exit? What growth rate is required? What has to go right?
Remember base rates. Most startups fail. Of those that don’t fail, most don’t generate meaningful returns for employees. The outcomes that make headlines, the early Googlers, the early Facebookers, are extreme outliers.
This doesn’t mean you shouldn’t join startups. It means you should join with clear eyes about what you’re actually buying. The mission might be worth it. The team might be worth it. The learning might be worth it. Just don’t confuse those things with the equity being worth it.
Thanks to [redacted] unicorn founders, Ethan Ding, Jake Cooper, Mike Vernal and others for providing comments and additions to this essay
Edit: Chris Paik (GP at Pace Capital) wrote a fantastic post explaining the same things with a viewpoint of LPs and GPs - this is a must read.
Great stuff
Love this, Nikunj! As someone who is joining an early-stage startup, this is so helpful to ask the right questions and negotiate better!