A Founder’s Guide to Correctly Calculating CAC and LTV

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Like a former venture capitalist, I always tell founders that the most powerful tool they can use when raising funds is a data-driven presentation.

Leading with data becomes even more valuable during periods of uncertainty and market volatility. When investors seek to reduce the risk of their investment decisions, coming to the negotiating table with solid evidence that reflects your company’s growth potential is the key to success for fundraising companies.

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Volumes of valuable real-time financial data are now at our fingertips thanks to cloud software, but without proper guidance – or data fluency – both founders and investors are missing out on leveraging these assets. I strongly believe that freer handling of data unlocks the potential not only of individual companies, but of an entire generation of founders from traditionally underrepresented backgrounds.

Zooming in a bit, there is one metric that companies need to use correctly to demonstrate their growth potential and attract investors: the LTV/CAC ratio.

What is LTV/CAC and why is it important?

Lifetime Value (LTV) and Customer Acquisition Cost (CAC) are two of the most common metrics used by both investors and companies to conduct cost-benefit analysis and ultimately predict a company’s value.

When companies acquire customers, it is best to view them not as one-time customers, but as long-term assets with cash flow. LTV helps both investors and companies calculate the long-term potential value of their customers, especially when they are expected to continue paying for goods and services over an extended period of time.

While founders looking for a high valuation may be hesitant to take a conservative approach, it can be critical to building investor confidence.

To attract these customers, companies must spend capital (using equity, debt, or free cash flow) on tactics such as paid advertising campaigns, sales force, and more. General expenses that contribute to the acquisition of a particular cohort of customers are considered CAC for that cohort.

Investors use LTV/CAC to measure whether a company’s short-term investments in sales and marketing are creating or destroying business value, and determine whether additional capital can effectively scale a business. Measuring the ratio between LTV and CAC allows investors to predict whether a company will give more money to spend on CAC, positive or negative ROI.

A low LTV/CAC ratio is a red flag as it shows that the company is inefficient in attracting valuable customers and will eventually require additional investment to grow. On the other hand, a strong LTV-CAC ratio indicates that an infusion of new capital could help boost growth exponentially.

Where do companies go wrong?

Many common mistakes come down to using the wrong metrics to tell your story. I often see how founders calculate LTV/CAC on income basewhen is the actual calculation of LTV/CAC on gross margin basis needed to finance growth.

Credit: techcrunch.com /

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