The False Confidence Of The LTV/CAC Ratio For Early Stage SaaS Startups

tomtunguz.com

Founders often describe their unit economics in terms of their LTV/CAC ratio – the ratio of the Lifetime Value (LTV) of a customer to the Cost of Customer Acquisition (CAC). The LTV/CAC metric can be a powerful metric to unpack the health of the go-to-market team of a company, as Netsuite has shown. But this figure is often meaningless for early stage startups.

Why? Because a company one or two or even three years into sales can’t yet accurately forecast customer lifetimes. If a business suffers from a very high churn rate, then, yes, it’s possible to calculate LTV in just a few years.

But most software companies will see 10% or less unit churn per year. At 10% unit churn, three years from now, 73% of customers will still be paying, adding to their LTV. How long will those customers stay? You could project a straight line churn, a fixed churn rate per year, but that may not be realistic. How will those businesses’ spend change over time? You won’t know until you see it for yourself.

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