You're about to land a deal with a huge customer, but before they sign that two-year deal, they have a request: they want to start with a Proof of Concept, or PoC. So, you agree to set them up with a shorter-term deal to make sure a contract will be beneficial for both sides.
When you’re an early-stage company, these short-term deals can make up a significant portion of revenue.
Naturally, founders want to get credit for this revenue when raising capital - but many struggle to understand how. Can this PoC revenue be reported as part of ARR? If not, how can you be sure it’s counted?
Let’s dive into some of these questions, and explore some ways you can use PoC revenue to catch the eyes of investors.
PoCs and recurring revenue 💰 💵 💸
When provided to prospective customers, PoCs can be paid or free. Generally speaking, we recommend that you charge for a PoC. This ensures that the prospective customer is genuinely interested in your product, and the cost creates incentive to sign a contract with you when the time comes. Plus, you should be paid for your work!
How is this revenue categorized, then? Can it be considered recurring and therefore be included in ARR?
The short answer is no. Recall that recurring revenue is revenue you can reasonably expect to recur.
When it comes to PoCs, your customer is undergoing the process specifically because they’re not sure your product is right for them. That means it’s not safe to bet on the customer’s continued use of your product.
Contrast this with a contract to provide a service for a longer period of time - for example, an annual contract. In most cases, when a customer has signed a deal, it’s because they already want what you’re selling. As long as your product performs as promised, your customers are likely to renew.
The difference between these two scenarios is the level of certainty. While neither is guaranteed, it’s still safer to bet on the renewal of a contract than on the signing of a new deal.
How can I get credit for paid PoCs when raising capital? 📈
If you’re early on, it may be that a large portion of your revenue comes from PoCs. Since investors often seek the stability provided by recurring revenue, it can be disheartening to hear that this revenue can’t be included in ARR.
Don’t worry - you can still get credit from investors for your revenue from PoCs! When reporting, simply specify that your total revenue includes both ARR and PoC revenue.
You can calculate the combined total of these two types of revenue by annualizing the PoC pay period. Here’s the formula:
To explain this further, let’s imagine your customers pay for your PoC on a quarterly basis. Since a quarter is 3 months, we put a 3 in the denominator of the fraction to arrive at a quotient of 4:
In addition to reporting actual ARR, you can report your anticipated ARR assuming that your customers will sign a deal with you at the conclusion of their PoC contract.
Imagine you have an ARR of $10K. You also have PoC contracts that, should the customers choose to sign with you, will increase your ARR to $25K. You can disclose that to potential investors - you just need to specify that the revenue is anticipated and not guaranteed.
If you’re using Subscript, you can list your PoC revenue as recurring - just make sure you tag it as PoC. For pure ARR reporting, exclude the tag. This can be done through the configuration of filters pictured below:
Why tag it? When you’re raising capital, you should be transparent about the inclusion of PoC revenue in your ARR. You should also clearly state what your ARR would be minus the PoC revenue.
Disclosure is crucial because any failure to do so could be interpreted as misleading by investors. On top of that, conversion rates from PoCs to long-term contracts tend to be lower than overall retention rates. If you’re including PoC customers with your contract customers, it will take a toll on your overall retention.
Of course, when raising capital, you’ll want to get credit for every penny you can. Just make sure you’re unambiguous about where those pennies came from.
If you’re raising capital and want to be credited for paid PoCs, Subscript can help. Our convenient, easy-to-use interface takes the legwork out of calculating and annualizing PoC revenue!