Before deciding to seek external investors for your startup, you need to be fully aware of the key performance indicators (KPIs) of your business, and most importantly, the LTV (customer lifetime value) and the CAC (customer acquisition cost). That is because when they invest in or purchase a firm, most investors will want to check these crucial metrics, and they should withstand investor scrutiny. The LTV:CAC ratio is calculated by dividing LTV by CAC, which indicates how much your company should spend to acquire a customer.
For instance, suppose you have an LTV of US$2,000 and a CAC of US$1,000. Then 2,000/1,000 = 2. It means, in your case, the LTV:CAC ratio is 2:1. Hence, you earn two times (2X) more from your average customer over their lifetime than what it costs you to acquire that customer. In other words, your average customer’s value is twice the cost of acquiring that customer. The higher or steeper the LTV:CAC ratio, the better the chances of your startup being able to raise funds. It is widely accepted that 3:1 is usually a good LTV:CAC ratio. It means your average customer is worth three times as much as it costs to acquire that customer.
Almost every business plan for fundraising includes forecasts and analysis on LTV and CAC. And when you know your LTV:CAC ratio very well and correctly perform the LTV/CAC analysis, you can accurately gauge your startup’s financial health. You will then be able to impress and convince prospective investors with insightful conversations easily. Furthermore, your chances of raising funds for your startup will immensely improve if you know how to increase the LTV and lower the CAC, as that can lead to higher profitability. As a business owner, you should always remain aware of your startup’s LTV:CAC ratio because a sudden dip in LTV or an unexpected rise in CAC can cause concern that you would have to attend to and resolve as soon as possible.
To facilitate the above calculations, let us now understand how the Customer Lifetime Value (LTV) and Customer Acquisition Cost (CAC) are arrived at. Generally, Customer LTV is equal to Lifetime Customer Revenue (LTR) minus Lifetime Customer Costs. So, the simplest method to calculate Customer LTV is subtracting the cost of acquiring and serving a customer from the Customer Revenue. Thus, LTV = Customer Revenue – Cost of Acquiring and Serving that Customer. Meanwhile, you can calculate the CAC by adding up your total sales, marketing, and other routine operational expenses incurred for customer acquisition over a given period and dividing it by the number of new customers acquired during that period. The figure that you get would be your firm’s estimated CAC.