In the investing world, the importance of knowing your LTV to CAC Ratio (LTV:CAC) gets a lot of airtime. Tech founders that pitch me as an investor have (or should have) this important stat at the ready; investors need performance metrics to evaluate how successful your organization (or a project or program of your organization) will be. Yes, knowing your LTV:CAC matters, but it’s not the whole story – at least not for me. When I look at your tech startup, I want to know your LTV:CAC, but I also want you to be able to expand from that to understand all of your KPIs and how those influence your OKRs, particularly in areas like FinTech and SaaS. Here’s why.
Top Reasons To Know Your LTV:CAC
LTV stands for Lifetime Value, which is the average gross margin you can expect to receive from a customer over their lifetime with your brand. CAC stands for Customer Acquisition Cost, which is how much you will need to spend to acquire a new customer. Your LTV:CAC is the ratio between those two numbers. You can learn a lot by knowing (and optimizing) that ratio.
Why does this matter? As industries become more and more competitive (especially in the volatile market changes and growth during this unprecedented pandemic) the relationship between your LTV and CAC can reveal the truth about the health of your organization, particularly as a high CAC can harm your long-term growth if a customer doesn’t stick around long enough or spend all that much with your brand.
In short: once I know your LTV:CAC, I know how much we could potentially make, and that knowledge is powerful because you need this knowledge to determine your KPIs and OKRs.
How Your LTV:CAC Gets You To Strategic KPIs and OKRs
As a founder, you need to have a goal and a plan and you’re not going to achieve either without measurable action steps. KPIs and OKRs are, essentially, goal-setting tools you can use to determine those steps and measure results. Once you have a clear picture of where you are (LTV:CAC), you can determine where you want to go (OKRs) and how you’ll get there (KPIs).
Key Performance Indicators (KPIs) are only valuable if they inspire action and they need to be unique to your business. KPIs target a particular goal (example: 80% form completion) and determine a timeline for the goal (quarterly, annually, etc.) as well as your action items and responsible parties for achieving it.
Objectives and Key Results (OKRs) are larger objectives that define measurable goals beneath them. An example of an objective would be to become the top healthcare tech billing solution. Key results under that objective would be identifying the top 5 features by a specific date or achieving 50 beta users.
The difference between KPIs and OKRs is the why behind them.
For me, KPIs are more useful to audit an existing process or solution and identify benchmarks to help set growth goals. I use OKRs to set ambitious goals, rally my internal team, and optimize performance. Both have their place.
Why You Need To Measure Performance
The old saying goes “what gets measured gets done,” but I think measurement is more powerful than simply checking the box: I believe that what gets measured gets optimized. I’m a champion for taking risks, making mistakes, and learning from them so that you don’t make them again. Without purposeful goal-setting and performance measurement, you don’t know what you’re doing wrong, or what you’re doing right. Implementing performance metrics can and will get you to your goals. At an early stage of a company, incremental growth with key metrics gets me excited – it indicates the market is accepting what you’re offering and is solving a need.
So You Still Want To Talk LTV: CAC?
That’s okay – you need to know it to put it into practice. Just remember – it’s the action the number inspires that matters, not the number itself.
Here’s the catch with LTV:CAC:
What and why are not the most important questions when it comes to LTV:CAC it’s When. To use LTV:CAC to drive business decision-making, it’s got to be meaningful and allow you (and your investors) to form predictions.
For LTV:CAC to apply to your business, you need to be in a stage where your growth is repeatable and scalable. So, you need to be able to look at where your leads are coming from and determine if those channels will be able to be scaled. If not – you’re not going to get accurate results for your sales process by calculating your LTV:CAC. That said, it’s still worth knowing, as you can use your LTV:CAC to help you determine KPIs for opportunities like pricing and optimizing your sales process.
What do I look for in a founder’s LTV:CAC?
A 1:1 (even) CAC means it cost as much to acquire your customer as you will make off them during their entire lifecycle with the brand. It’s obvious why this isn’t great news. The same goes for lower LTV than CAC, 1:1.25, which occurs when you’re making less during the entire lifecycle of a customer than it cost to acquire them. Given that acquiring customers is not your only cost, it doesn’t take much to see that you’re losing money on every customer you acquire. But, see more about when you should be calculating this ratio below.
Where things start to get interesting is when LTV is higher than CAC. But, by how much?
Typically, I like to see around a 3:1, but this number can change for me depending on the industry or type of investment. In the tech startup space, which is my main area of focus, I am certainly willing to take risks – just not stupid ones. A 2:1 – 4:1 LTV:CAC might get my interest, particularly in the early stages common for companies seeking angel investors, but 5:1 would certainly do the job.
What about a 5:1 LTV:CAC?
When LTV is this much higher than CAC it tells me there needs to be scaling up because there’s untapped growth potential being left on the table.
How to Calculate Your LTV:CAC
There is an unlimited amount of information on this topic on the internet, but to keep it simple: you’re going to divide a single customer’s average LTV by their CAC to get your LTV:CAC. That number will give you a basic understanding of your ROI for every dollar spent attracting a consumer.
How to Talk to Me About Your Performance Metrics
No one that’s bringing me KPIs, OKRs, or LTV:CAC in their pitch deck is going to be showing me weak ones (at least not intentionally). While I love to see strong metrics, what I want to see is that a founder clearly understands the logic behind them and that they’re thinking strategically about how it will impact future decisions and growth of their organization. Your metrics aren’t interesting to me as observations of past and current performance; instead, they’re a window into the future of how profitable we’ll be together.
There are a lot of misconceptions out there when it comes to metrics – particularly for tech startups, most of which don’t survive. Even if it’s early, start thinking about what your current success (or lack thereof) says about where your company is going in the future. Your LTV:CAC is just one piece of the puzzle – but it’s a critical one that can get you to powerful KPIs and OKRs. If you’ve got a firm understanding of what your metrics say about your future success and what you’re going to do to improve them as a tech startup founder – I want to hear it.
Enjoy the ride.