A founders guide to calculating CAC and LTV the right way –

    as former venture capitalist, I always tell founders that the most powerful tool they can use in fundraising is a data-driven pitch.

    Leading the way with data is even more valuable during periods of uncertainty and market volatility. With investors looking to reduce their investment decisions, coming to the table with hard evidence that reflects your company’s growth potential is the key to corporate fundraising success.

    Thanks to cloud software, we now have large amounts of valuable, real-time financial data at our fingertips, but without the right guidance — or fluid data sharing — founders and investors alike miss the opportunity to leverage these assets. I firmly believe that increased data flow unlocks the potential not only for individual companies, but also for an entire generation of founders from traditionally underrepresented backgrounds.

    Zooming in a little further, there is one metric that companies need to get right to demonstrate their growth potential and attract investors: their 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 commonly used metrics used by investors and businesses alike to make a cost-benefit analysis and ultimately predict a company’s value.

    When companies acquire customers, the right way to view that customer is not just as a one-time buyer, but as a long-term cash flow asset. LTV helps both investors and businesses calculate the long-term potential value of its customers, especially when they are expected to continue paying for goods and services over an extended period of time.

    While founders may be hesitant to take a conservative approach in view of high valuations, this can be critical to building investor confidence.

    To acquire these customers, companies must spend capital (whether in equity, debt, or their free cash flow) on tactics such as paid advertising campaigns, sales force, and more. The total costs that contribute to acquiring a particular cohort of customers are considered the CAC for that cohort.

    Investors use LTV/CAC to measure whether a company’s short-term investments in sales and marketing create or destroy value for the company and to determine whether additional capital helps the company scale efficiently. By measuring the ratio of LTV to CAC, investors can predict whether giving more money to CAC will give a company a positive or negative ROI.

    A low LTV/CAC ratio is a red flag as it shows that the company is not efficiently acquiring high-value customers and will ultimately require more investment to grow. On the other hand, a strong LTV-CAC ratio indicates that injecting new capital can help accelerate growth exponentially.

    Where do companies go wrong?

    Many common mistakes come down to using the wrong stats to tell your story. I often see founders calculating LTV/CAC on a income basewhile in reality LTV/CAC is calculated at a gross margin basis necessary for growth financing.

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