top of page
  • Writer's pictureJasaro In

Why Do VCs Love LTV:CAC Ratio?

Source: Marc Penkala


Prior reads:


Improving LTV:CAC Ratio from 2X to 3X may Triple Startup Valuations

Customer Life Time Value (LTV):Customer Acquisition Costs (CAC) ratio is a moving target, most early-stage startups can only guess what this essential metric looks like and moreover how it will evolve in the future.


However for VCs, it's a central element of their assessment - that's why:

Improving LTV:CAC Ratio from 2X to 3X may Triple Startup Valuations


Higher LTV:CAC Ratio and Financial Health

  • A higher LTV:CAC ratio indicates efficient returns on sales and marketing spend.

  • If a company's LTV is at least 3X its CAC within a specific timeframe, it suggests the company has solid unit economics and financial health.



Impact on Margins and Valuations

  • A higher LTV:CAC ratio leads to higher margins and, consequently, a higher valuation for the company.

  • The relationship between these factors is illustrated as Higher LTV:CAC = Higher Margins = Higher Valuation.



Unit Economics and Business Growth

  • Improved LTV:CAC ratios result in more profit available to reinvest in the business, which can lead to better product development and an increased ability to capture market demand.

  • Companies' valuations are largely based on their future cash flow generation, with higher margins contributing to higher valuations.



Valuation Multiplier and Profitability

  • A company's value is determined by its future cash flows. More profitable companies are valued higher, as they can generate more profit from each dollar earned.

  • Higher margins from a higher LTV:CAC ratio leads to a greater valuation multiplier.



Balance Between Growth and Margins

  • While both growth and margins are important, the market context (as of 2023) has been favoring companies with higher margins over those with higher growth rates.



Summary


LTV:CAC is a cornerstone metric for startups, especially when we consider the scalability and sustainability of a business model.

It serves as a critical metric for assessing the efficiency and financial health of startups.

Companies with higher LTV:CAC ratio generally enjoy higher margins and valuations, due to their ability to generate more profit from their customer acquisition efforts.

12 views0 comments

Comments


bottom of page