Evolv Technology (“Evolv”), which provides AI -based security screening to clients including sports teams and stadiums, announced that its previous two years of financial statements can no longer be relied upon, a stunning development for one of sports tech’s darlings.

The decision was based on preliminary results from an internal investigation into sales practices. That investigation, previously unknown to the public, is still ongoing, so releasing this news now likely means the evidence is damning.

I’ve been monitoring this story carefully, because, reading the disclosures, and having investigated hundreds of similar matters, it’s clear the problems are symptomatic of broader issues in the sports and software-as-a-service (”SaaS”) industries.

A rising star

Evolv’s flagship product, the “Evolv Express”, uses sensors and Artificial Intelligence (“AI”) to make securely entering buildings, such as stadiums, quicker and simpler. Two-thirds of the Company’s revenue is earned through subscriptions, whereby customers get the Evolv Express product and access to its intelligence software.

That technology and business model has generated considerable growth. The company went public through a reverse merger in 2021, won “Best in Sports Technology” from Sports Business Journal in 2024 and has contracts with over 50 major pro and collegiate sports venues in the US and England.

But the issues stem from these agreements. According to the company, certain sales included ex-contractual arrangements – side terms not included in the main contract.

Nightmare for Evolv’s finance team

Evolv’s accountants, relying on the written contract, believed the Company’s had met their client obligations and recorded revenue in line with United States Generally Accepted Accounting Principles (GAAP). The company’s auditors likely used those contracts for support. But neither were aware that the Company had further obligations to certain clients.

Evolv estimates overstated revenue between $4m-$6m over a 2-plus year period. That may seem trivial since Evolv’s most recent quarterly revenue was $25m. But those numbers are net of premature revenue that corrected in a later period. Individual period financial impacts were material enough that every financial statement since June 2022 could no longer be relied upon.

No disclosures on the ex-contractual obligations but I have theories

Like other technology companies, Evolv’s subscription agreements include multiple components, such as the product and related software. Accounting principles require those components to be treated separately, and so the company proportionally allocates revenue based on market prices.

That increases the complexity – and the risk. Consider this hypothetical; a customer signs a contract to buy the Evolv Express and subscribe to its software. The product is installed at a stadium, the subscription starts, and the customer begins paying installments. The Company would likely record the revenue for the product component upon installation because the risks and rewards of ownership had transferred.

But what if Company personnel had promised – outside of the contract – to take the product back if certain benchmarks weren’t met?

Complex leases potentially a factor

There’s also another possibility. 46% of the Company’s 2023 revenue came from leasing, not selling, the Evolv Express. That creates the opposite problem; the risk that company personnel promised clients, ex-contractually, a discounted or free purchase option at lease-end. Such a promise, referred to as a bargain purchase option, could materially alter revenue calculations and balance sheet classifications.

Coincidentally – or perhaps not – the company was required to adopt a more complicated lease standard in 2022, the same year these accounting issues began. In fact, the Company’s June 2022 quarterly financials (the “10Q”) were delayed for immaterial misclassifications to leases, warrants and cost of sales. That’s a bingo for complicated accounting topics.

Technology sector risks

In this industry, companies are built on proprietary technology, but that creates pressure if the product falters or isn’t adopted at scale. That likely applies at Evolv, where the Chief Innovation Officer had admitted that its Chief Executive Officer, “sometimes exaggerated the…performance”. And though the company has grown, they acknowledge a “history of losses” and a risk they “may not achieve or maintain profitability in the future”.

Now, that’s not atypical for an industry that runs a consistent playbook: spend to develop an impactful product (most R&D costs are not capitalizable), scale like crazy, make investors happy. But the caveat is that strategy requires an aggressive sales function.

And that sales function is usually rewarded for securing Annual Recurring Revenue (”ARR”) because investors place higher multiples on predictable cash flows. That incentivizes sales teams to lock in subscription contracts.

Coincidentally – there’s that word again – in its most recent filing, 83% of the company’s $25m quarterly revenue was deemed recurring, and the Company was forecasting $100m in ARR by December 31, 2024.

Exacerbated by Sports

I refer to Sports as a “Halo Industry” because headlines are monitored by stakeholders in unrelated sectors. Evolv might agree; they regularly tout their Sports Business Journal awards in SEC filings. But that pushes companies to chase headlines through new sports transactions.

The industry’s growth enhances the risk that internal controls and processes haven’t kept pace, as I’ve written about elsewhere. For example, at other public companies, accounting policies include language prohibiting formal or informal “side letters”. It’s unclear if that existed at Evolv.

And controls are also only as effective as the tone at the top. That’s why Directors are also investigating senior personnel, including potentially the Chief Executive Officer, who previously oversaw sales. There’s also a separate – and still ongoing – Securities and Exchange Commission investigation into Evolv’s marketing practices.

Difficult to catch but not impossible

Identifying ex-contractual terms is challenging; just look at the fraud by former Sacramento Kings Chief Revenue Officer, Jeffrey David. But regulators view confirming Accounts Receivable and key contract terms as an essential part of auditing.

It also should be an essential part of fraud due diligence during transactions and funding. Evolv previously took outside money from firms like Finback Investment Partners, General Catalyst and SineWave, and went public in 2021. It’s fair to wonder if such procedures were performed at any point.

Concern moving forward

When the economics of technology companies are mixed with the high-profile nature of sports and the realities of investor pressure, it creates an atmosphere for potential fraud.

Thankfully, Evolv’s directors are overhauling governance and assuaging investors. The CEO has been replaced, and it’s safe to assume that company personnel and vendors are working hard to finish the investigation and remediate control gaps. Auditors won’t sign off on the Company’s next year-end financials until they do.

But this will happen again, if not at Evolv, then at another public – or private – company, especially as the underwhelming early returns from AI create investor pressure. It’s been said that when the tide goes out, we see who’s swimming naked.

Hopefully lessons are learned in the meantime.

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