This is a guest article from Founders Advisors Vice President Brad Johnson. We hope you enjoy it!

LTV:CAC – What is it?

Lifetime Value : Customer Acquisition Cost (LTV:CAC) is the measure of return a SaaS business is generating on its customer acquisition spend. This can be thought of as the ROIC (return on invested capital) of customer acquisition spend.

While there are many ways to calculate LTV:CAC, below is our recommended formula. This metric is typically calculated as an average of a particular customer cohort.

LTV = (# Customers in Cohort) x (Average Recurring Revenue per Customer) x (Gross Margin) x (1 / Customer Churn Rate)

CAC = (Sales and Marketing Spend + Onboarding Costs) / (Customers Onboarded)

So What Does it Mean for SaaS Businesses?

LTV:CAC is a powerful metric to measure the health of a SaaS business because of the number of underlying factors that are taken into consideration when calculating the metric.

Quantitative factors considered include Retention Rate, Average Revenue per Customer, and Gross Margin

Qualitative factors considered include Efficiency of: Sales and Marketing; Customer Success/Retention Team; Onboarding; Product Design and Technology; and Product Support

Several Additional Things to Keep in Mind

Calculating Customer Lifetime Value – Calculating customer lifetime value can be different for every business. The best method to calculate LTV will be dependent on the company’s specific pricing model.

Gross Margin – One factor often forgotten when calculating LTV is gross margin. When calculating LTV, it is important to consider all platform and service costs needed to service the revenue generated during a customer’s lifetime.

Fully-loaded Customer Acquisition Cost – When determining customer acquisition cost, it is important to factor in not just the sales and marketing costs associated with customer acquisition but also the customer onboarding costs.  

Early-stage Companies – For companies in their first 3 years of operations, determining an accurate LTV can be challenging due to the limited data available. For these companies, CAC payback period is often a more reliable measure of efficiency.

Sources: Kissmetrics, Tomasz Tunguz, Ron Gill (CFO, Netsuite) 

About Founders

Founders Advisors (Founders) is a merger, acquisition and strategic advisory firm serving lower-middle-market companies. Founders’ focus is on nationwide energy, industrial, SaaS/software, internet, industrial technology, healthcare, digital media, consumer, and value-added distribution companies as well as companies based in the Southeast across a variety of industries. Founders’ skilled professionals, proven expertise, and process-based solutions help companies access growth capital, make acquisitions, and/or prepare for and execute liquidity events to achieve specific financial goals. In order to provide securities-related services discussed herein, certain principals of Founders are licensed with M&A Securities Group, Inc. or Founders M&A Advisory, LLC, both members FINRA & SiPC. M&A Securities Group and Founders are unaffiliated entities. Founders M&A Advisory is a wholly owned subsidiary of Founders.

For more information, visit www.foundersib.com.