The Hot ARR Deck

Question 20: The Hot ARR Deck

Your role

You are counsel to Northgate Metrics, a private software company, called by its CEO twelve days before the scheduled signing of a $40 million Series B financing at a $220 million pre-money valuation. A problem has surfaced in the fundraising deck. Advise the company and its board.

Governing law

1. In connection with the purchase or sale of a security, it is unlawful to make an untrue statement of a material fact or to omit a material fact necessary to make statements made not misleading. Liability requires scienter, which includes recklessness. This applies to private placements.

2. A fact is material if there is a substantial likelihood a reasonable investor would consider it important, viewed against the total mix of information.

3. Projections and other forward-looking statements accompanied by meaningful, specific cautionary language are protected. The protection does not extend to misstatements of present or historical fact, and boilerplate cautions are not meaningful.

4. A purchaser induced by material misstatement may pursue damages or rescission. Correction of a misstatement before an investor becomes irrevocably committed can cut off reliance for that investor.

5. A person who sells securities while in possession of material nonpublic information about the issuer, to a buyer without that information, violates the antifraud rules. This includes founder secondary sales in a private financing.

6. Directors owe a duty of candor to the shareholders and good-faith oversight of the company's disclosures. Approving a financing known to rest on misleading materials implicates loyalty, not merely care.

7. Indemnification and directors-and-officers insurance do not cover liability finally adjudicated to arise from fraud.

Facts

Northgate's Series B deck, used with every prospective investor, states:

"ARR: $14.2M. Net revenue retention: 138%."

Diligence preparation this week surfaced the composition of that figure. It includes $2.6 million of one-time implementation-services fees and a $1.1 million contract that is signed but not yet live, terminable by the customer on 60 days' notice before go-live. Recurring subscription revenue on the standard definition is approximately $10.5 million. The 138% retention figure was computed on a customer cohort that excludes the two largest accounts lost during the year; including them, retention is 111%.

The CFO, asked about the definition months ago, wrote in an email now in the diligence folder:

"Everyone counts pipeline-adjacent. Keep the number. We can true it up after the round."

The deck's final slide contains a general disclaimer that projections "involve risks and uncertainties."

The round's anchor investor wired an $8 million first tranche two weeks ago under a signed subscription agreement, based on the deck. The remaining $32 million is committed by term sheet but unsigned, with signing in twelve days. As part of the round, the founder is selling $4 million of her own shares to the incoming investors.

Yesterday, Northgate's second-largest customer, 9 percent of subscription revenue, delivered a non-renewal notice effective at term end in four months. No investor knows this.

The CEO proposes: "Sign on schedule. The business is real. We fix the metrics deck for the Series C." The board meets in two days.

Assignment

Analyze:

• Whether the ARR and retention figures are misstatements of present fact or protected projections, applying the supplied rules to each number and to the disclaimer.
• Materiality: quantify the gaps and assess them against the total-mix standard, including the non-renewal notice.
• Scienter: the effect of the CFO's email, and who is exposed, company, CFO, CEO, directors.
• The anchor investor's wired $8 million: the company's options, what correction can and cannot cure for that investor, and whether rescission should be offered.
• The unsigned $32 million: what correction before signing accomplishes under the supplied reliance rule, and what the corrected disclosure must contain, including the customer non-renewal.
• The founder's $4 million secondary in light of the nonpublic non-renewal notice: may it proceed, on what conditions, or must it be pulled.
• The board's position under the candor and oversight rules if it follows the CEO's proposal, and the exculpation and insurance consequences of proceeding knowingly.
• The repricing conversation: how to present corrected metrics, the likely valuation impact, and whether delay, reprice, or restructure best protects the company.
• A concrete 48-hour plan for counsel: the corrective disclosure, the anchor remediation, the secondary decision, and the board resolutions, in order.

Q20 key (Hot ARR Deck)

1. The ARR and retention figures are misstatements of present fact: $14.2 million versus roughly $10.5 million on the standard definition, and 138 percent computed by excluding the two largest lost accounts versus 111 percent. The generic risk disclaimer protects neither, because the safe harbor covers projections, not present-fact statements, and the caution is boilerplate. Missed: the problem is misclassified as puffery or protected forecasting.
2. Materiality is not close: a roughly 35 percent ARR overstatement and a 27-point retention gap in a metrics-driven valuation, plus a 9 percent-of-revenue customer non-renewal, each independently alters the total mix. Missed: the board is advised it can proceed.
3. Scienter: the CFO's "keep the number, true it up after the round" email is direct evidence of knowledge; the CEO and directors acquire scienter the moment they learn and proceed. Exposure runs to the company, the CFO personally, the CEO, and any director who approves signing on the uncorrected deck. Missed: the individuals are not told they are personally in the frame.
4. The anchor's wired $8 million cannot be cured by correction; the misstatement preceded an irrevocable commitment. The defensible course is full corrective disclosure to the anchor plus an offer of rescission or ratification on corrected terms, documented. Missed: the strongest claimant is left holding an unremediated fraud claim.
5. The unsigned $32 million can be saved: corrective disclosure before signing cuts off reliance, and the correction must include the true ARR composition, the recomputed retention, and the customer non-renewal notice. Missed: the reliance cure is squandered by a partial correction.
6. The founder's $4 million secondary cannot proceed while she possesses the nonpublic non-renewal information; it goes forward only after full disclosure to the buyers or it is pulled from the round. Missed: an insider-sale violation is layered onto the deck problem.
7. Board duties: following the CEO's plan after this meeting is a knowing-disclosure problem sounding in loyalty and good faith, outside exculpation, with fraud carve-outs threatening indemnification and insurance. The board must direct correction, not schedule-keeping. Missed: the directors burn their own protections.
8. The 48-hour plan: board resolutions directing corrective disclosure and pausing the secondary; corrected metrics package and non-renewal disclosure to all investors; anchor remediation offer; reprice-or-delay negotiation with the lead; document every step. Signing on schedule on the current deck is the one indefensible option and the answer must say so. Missed: the twelve-day clock is obeyed and the company inherits the liability.