The Truth Behind the Numbers: ARR, MRR, and Why Buyers Interrogate Your Revenue
Every founder believes their recurring revenue tells a straightforward story. The numbers are in the billing system, the MRR schedule matches the bank deposits, and ARR is simply MRR times twelve. What more is there to discuss?
Buyers see it differently. To an experienced acquirer, ARR and MRR are claims that require validation. The headline figures are starting points for investigation, not conclusions. The due diligence process exists precisely because revenue numbers, even accurate ones, can obscure as much as they reveal.
Understanding why buyers scrutinise recurring revenue so intensely, and what they are actually looking for, helps founders prepare for the examination that every acquisition entails.
The Gap Between Reported and Validated Revenue
When a seller reports $3M in ARR, the buyer immediately asks: what does that number actually represent? The question is not hostile. It reflects the reality that "ARR" means different things to different companies, and even well-intentioned founders often calculate it in ways that do not align with buyer expectations.
Consider the variations. Some companies include professional services revenue in their ARR calculation. Others include setup fees, amortised over the contract term. Some count customers who have cancelled but have not yet reached their contract end date. Others exclude month-to-month customers entirely, counting only annual contracts.
None of these approaches is necessarily wrong, but they produce different numbers from the same underlying business. A buyer applying a 5x multiple needs to know exactly what they are multiplying. The validation process ensures the ARR figure reflects genuinely recurring, contractually obligated subscription revenue, nothing more and nothing less.
What Buyers Actually Verify
Financial due diligence in SaaS transactions focuses intensely on revenue quality. Research on buyer practices confirms that acquirers request specific documentation and perform systematic verification across several dimensions.
Billing System to Bank Reconciliation
The first check is mechanical: does cash actually arrive matching what the billing system shows? Buyers trace revenue from invoices to bank deposits, looking for discrepancies that might indicate uncollectable revenue counted as ARR, timing differences that distort reported figures, or manual adjustments that lack documentation.
This reconciliation often surfaces issues founders did not know existed. Refunds processed outside the billing system. Failed payment retries that were never resolved. Credits applied manually without corresponding adjustments to reported metrics. Each discrepancy requires explanation and potentially adjustment.
Contract to Revenue Mapping
Buyers verify that reported MRR ties to underlying contracts. For each customer, what is the contractual obligation, what is the billing amount, and what is the recognised revenue? These should align. When they do not, questions arise about revenue recognition accuracy.
Deloitte's guidance on SaaS revenue recognition emphasises that ASC 606 compliance introduces complexity around performance obligations, standalone selling prices, and variable consideration. Buyers verify that companies handle these complexities correctly. Errors in revenue recognition can delay transactions or reduce valuations.
Cohort Behaviour Analysis
Beyond verifying current numbers, buyers analyse how revenue behaves over time. Cohort analysis tracks customers acquired in specific periods through their lifecycle. How much revenue did January 2022 customers generate in month one, month twelve, and month twenty-four?
This analysis reveals patterns that aggregate figures obscure. Perhaps early cohorts show strong retention while recent ones decay rapidly, suggesting product or market changes. Perhaps certain acquisition channels produce customers who churn quickly while others produce long-term subscribers. Cohort behaviour predicts future performance better than current snapshots.
Customer Concentration and Dependency
Buyers examine what percentage of revenue comes from the largest customers. High concentration creates risk: a single customer departure could devastate the business. Industry analysis confirms that experienced buyers scrutinise concentration carefully, assessing both the statistical reality and the relationship strength with key accounts.
For lower middle market transactions, some concentration is inevitable. A business with 50 customers will necessarily show higher concentration than one with 500. But concentration above certain thresholds, typically 10% for any single customer or 40% for the top five, requires careful discussion of customer relationships, contract terms, and retention probability.
Churn and Retention Metrics
Buyers calculate churn and retention independently, using the raw data rather than accepting reported figures. Gross revenue retention, net revenue retention, logo churn, and revenue churn each tell part of the story. Discrepancies between reported and calculated metrics are red flags.
The calculation methodology matters. Are churned customers removed immediately or at contract end? Are paused customers counted as active? Are downgrades counted in contraction or churn? Different answers produce different metrics from identical underlying data. Buyers want to understand the methodology and often recalculate using their own standards.
Common Revenue Issues Buyers Discover
Certain patterns recur across transactions. Founders preparing for sale should address these proactively.
Inflated ARR from Non-Recurring Sources
Some businesses include revenue that does not truly recur in their ARR calculations. Professional services billed monthly might be counted despite requiring new project scopes. Usage overages might be included despite being unpredictable. One-time fees might be amortised to create artificial recurring appearance.
Buyers strip these out. The adjustment reduces ARR and, because valuation is a multiple of ARR, directly reduces enterprise value. Founders who present clean ARR from the start avoid the psychological impact of apparent valuation reduction during diligence.
Deferred Revenue Misalignment
When customers pay annually upfront, the cash arrives immediately but revenue is recognised over the contract term. Deferred revenue, the gap between cash collected and revenue recognised, should appear on the balance sheet. Buyers verify this reconciliation to confirm that revenue recognition is proper and that reported ARR reflects actual contractual obligations.
Misalignment between deferred revenue and ARR suggests recognition timing issues. Either revenue is being recognised too early, overstating current performance, or too late, creating hidden value. Neither situation is ideal; buyers want clean alignment with standard practices.
Customer Quality Issues
Not all customers are equally valuable. Buyers assess customer quality through several lenses: creditworthiness, retention history, expansion potential, and strategic fit. Revenue from struggling startups or customers with payment histories carries less value than revenue from stable enterprises.
During diligence, buyers often discover that a portion of reported ARR comes from customers who are already showing churn indicators: reduced usage, support escalations, payment delays, or downgrade requests. This "at-risk ARR" gets discounted in valuation discussions, sometimes significantly.
Inconsistent Methodology Over Time
Changes in how ARR is calculated create comparability problems. If the company changed its calculation methodology two years ago, historical trend analysis becomes unreliable. Buyers want consistent methodology throughout the period they are examining, typically three to five years.
When methodology changes have occurred, document them clearly. Explain what changed, when, why, and how the numbers would look under consistent methodology. Proactive disclosure is far better than discovery during diligence.
The Interrogation Process
Understanding how buyers structure their revenue examination helps founders prepare effectively.
Document Requests
Buyers begin with extensive document requests: MRR schedules, billing system exports, contract copies, bank statements, and financial statements. These documents allow independent verification of reported figures.
The quality of your response matters. Analysis of buyer practices confirms that clean, well-organised documentation signals operational maturity. Messy, incomplete, or inconsistent documentation raises questions about what else might be problematic.
Analytical Procedures
Using the provided documents, buyers perform analytical procedures: recalculating ARR from raw data, building cohort analyses, testing retention calculations, and verifying reconciliations. These procedures often surface discrepancies that require explanation.
Expect questions. Even clean businesses generate questions during analytical review. The issue is not whether questions arise but whether you can answer them credibly and completely.
Management Discussions
Buyers interview management to understand revenue drivers, customer relationships, and operational practices. These discussions probe beyond numbers into the business reality that produces them.
Common questions include: How do you acquire customers? What drives expansion? Why do customers churn? Which customer segments perform best? What is changing in your market? The answers contextualise the quantitative analysis and affect buyer confidence.
Preparing for Revenue Scrutiny
Founders can take specific steps before a transaction to improve revenue credibility.
Standardise Your Calculations
Adopt standard ARR and MRR calculation methodologies aligned with industry practice. Exclude one-time revenue, professional services, and unpredictable usage. Document your methodology explicitly so it can be verified.
Build Complete MRR Schedules
Your MRR schedule should track every customer, every month, with full segmentation by product, geography, customer type, and acquisition channel. The schedule should tie perfectly to your billing system and financial statements.
Reconcile Everything
Before diligence begins, perform the reconciliations buyers will request. Billing system to bank deposits. Contracts to revenue. Deferred revenue to ARR. Any discrepancies you find are better addressed proactively than discovered under scrutiny.
Understand Your Cohorts
Build cohort analyses showing customer behaviour over time. Know which acquisition periods produced your best customers and which produced your worst. Understand the patterns and be prepared to explain them.
Address Issues Now
If you know issues exist, address them before the process begins. Customers on month-to-month who should be on annual contracts. Billing disputes that have not been resolved. Recognition timing that might be questioned. Every issue addressed now is one that will not derail your transaction later.
The Credibility Premium
Clean revenue presentation affects more than due diligence efficiency. It affects valuation.
Buyers pay more for certainty. A business whose revenue survives intense scrutiny without adjustment commands higher multiples than one whose ARR gets marked down during diligence. The adjustment itself is damaging; the buyer questions what else might be wrong.
The psychological dynamics are real. An LOI based on $3M ARR that gets adjusted to $2.7M ARR during diligence feels like a 10% price reduction, even if the multiple remains unchanged. Founders who present accurate figures from the start avoid this perception.
Experienced buyers discount for uncertainty. When documentation is poor or calculations are unclear, buyers assume the worst and price accordingly. Clear, verifiable revenue metrics remove the uncertainty discount and support the valuations founders seek.
If you are preparing for a transaction and want to discuss revenue presentation and diligence preparation, we welcome the conversation.