SaaS Metrics: LTV, CAC, CAC Payback Periods, and More

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In this lesson, you’ll learn how to calculate important financial metrics for Software as a Service (SaaS) companies, such as Lifetime Value (LTV), Customer Acquisition Costs (CAC), LTV / CAC, and the CAC Payback period; you’ll also learn their advantages and disadvantages and why they can be deceptive unless they’re properly adjusted.
Resources:
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Table of Contents:
0:00 Introduction
1:16 The Short Answer
5:44 Part 1: Why the “Lifetime Value” Calculation is Tricky
13:32 Part 2: Calculating Customer Acquisition Costs (CAC)
15:30 Part 3: Is LTV / CAC Useful or Deceptive?
19:52 Part 4: A Better Alternative: CAC Payback Periods
23:32 Part 5: Other Common SaaS Metrics
26:43 Recap and Summary
The Lifetime Value (LTV) Calculation
You start by estimating how many years the average customer will stay and keep paying, multiply by the amount paid per year, and then multiply by the company’s gross margin percentage (sometimes with other adjustments included).
The most common formula for "average lifetime," which could be in months, quarters, or years, is:
Average Lifetime = 1 / Churn Rate
So, if the company has annual contracts, and 20% of customers cancel each year, the “average” customer stays for 5 years.
But it’s not quite that simple for startups because these lifetime estimates tend to be wildly overstated and must be discounted for market, product, customer, and funding risk.
A better formula for a company with annual contracts is:
Average Lifetime in Years = 1 / (Annual Cancellation Rate + Discount Rate)
You could factor in price increases if they’re contractual and set in advance, or you could just use the current rates.
LTV = Average Amount Paid per Year * Average Lifetime in Years * Gross Margin %
The Customer Acquisition Costs (CAC) Calculation
The main questions here are which expense to include and whether the company discloses enough information to separate out these expenses.
You typically include expenses such as marketing salaries/benefits, paid advertising, commissions paid on new customer sales, and executive time/money spent to win new customers.
Including salaries and benefits for sales reps and employees is more complicated because you should, technically, split it between new and renewal sales reps; similar splits apply to expenses such as employee onboarding, overhead, and travel.
Uses of LTV / CAC
LTV / CAC is a useful metric, if calculated and adjusted properly, but like all financial metrics, it’s not a "law of nature."
The biggest issue is that most startups have a very limited data set and operating history, which means that LTV can be greatly overstated unless you adjust it based on a Discount Rate.
LTV / CAC is best used to compare two similar startups in similar growth stages to assess which one is operating more efficiently and winning higher-value customers.
There is a “rule” online that an LTV / CAC of 3x or above is “good” or the “target” for most SaaS companies, but this is a very rough guideline at best.
It’s true that no company wants a very low LTV / CAC, such as a number below 1x, but there is so much subjectivity in the calculation that strict rules do not necessarily mean that much.
The CAC Payback Period
A better alternative to LTV / CAC is the CAC Payback Period, which tells you the number of months it takes a company to recoup the average sales and marketing costs required to win a new customer.
There are different ways to calculate it, but one common method is as follows:
CAC Payback Period = Monthly Customer Acquisition Costs / Net New Monthly Recurring Revenue
Net New MRR = (Additional Monthly Subscription Revenue from New Customers - Lost Monthly Subscription Revenue from Cancelling Customers) * Gross Margin %
This metric is more useful because it’s shorter term and does not require predictions about customer behavior in 5-10 years; you also don’t need to adjust it based on the Discount Rate, price increases, cancellation rates, or anything else.
Shorter is better with this one, so a company that recoups its sales and marketing costs in 6 months rather than 12 months is viewed more favorably, assuming the same contract lengths.

[@financialmodeling]

Files & Resources: youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com/Startups-VC/SaaS-Metrics.xlsx youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com/Startups-VC/SaaS-Metrics-Slides.pdf youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com/Startups-VC/Confluent-10-K.pdf youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com/Startups-VC/Confluent-Investor-Presentation.pdf

[@haroldjiang6958]

Love it. Good to know that this channel is actively tracking the hot topics on the market! Please keep the SaaS stuff going. Thank you

[@financialmodeling]

Thanks for watching!

[@jayliu645]

Thanks for the point on the "Gross Retention", great point ! Net Retention seems mask many underlying variables.

[@Talib_Husain18]

really amazing content, sooo informative and comprehensive. Thank you so much

[@financialmodeling]

Thanks for watching!

[@user-ru9oi2qh1b]

Really helpful and understandable! Thank you for sharing and keep going with more amazing videos with us! 🙌

[@financialmodeling]

Thanks for watching!

[@BetoMexicano]

Thank you, this was an enlightening video.

[@financialmodeling]

Thanks for watching!

[@seobombisgay]

damn cac payback is genius. as a marketing director, I'll be adding this to our metrics report.

[@financialmodeling]

Glad to contribute to humanity.

[@JoshOlawale]

Can’t wait til you release the case studies

[@financialmodeling]

Coming soon!

[@elijahgachohi6788]

@@financialmodeling Eagerly awaiting the case studies, especially the Confluence one.

[@isaacluo3193]

Thanks Brian，really love your video！It would be really helpful if you can elaborate the point where you made in the last part. You said if the net retention is 110%, the churn rate is at least 10%. Thank you very much in advance!

[@John-thinks]

I believe the idea is that a 20% price increase would mean 20% increase in profits and thus you "retain" 120% of previous period's revenue in a scenario where nobody unsubscribed. So if you have a net retention of 110% after the 20% price increase, then you've lost some customers. Remember: Revenue is price per subscription * quantity of subscriptions sold. So if price went up by 20%, then quantity sold had to decrease (~10%, although I think the math is slightly trickier than this in reality?) to get you to the 110. Hope that helps.

[@financialmodeling]

What John said below (thanks for responding). Essentially, price increases can distort a metric like "net retention" because a company could cover up a poor cancellation rate just by raising prices substantially on the remaining customers. In fact, sometimes a big enough price increase could *cause* a higher cancellation rate. So when a company presents a "net retention rate" of over 100%, you always want to ask about the effect of price increases and license expansions vs. cancellations.

[@kambizraoufi]

@Mergers & Inquisitions / Breaking Into Wall Street many thanks for taking the time to share such a great lesson with the community. Could you share the link to the Excel file. Thank you

[@financialmodeling]

Thanks. You can click "Show More" and scroll to the links below.

[@nilayagarwal9416]

More videos on SaaS and VC related topics please

[@financialmodeling]

Thanks. We have just posted several recently if you look at the recent uploads.

[@nilayagarwal9416]

thanks. appreciate the efforts.@@financialmodeling

[@brandonkim4044]

Really enjoying your videos! Just wondering if you have any plans to make Shipping & Aviation Metrics as well? Appreciate it

[@financialmodeling]

Thanks. We do have a full case study of EasyJet in our financial modeling course. I don't know that there's enough to say about just the metrics and ratios to make for an interesting/useful separate video here, but maybe.

[@wetdon591]

Hi, thanks for the video. I just want to understand the rationale with subtracting the lost revenue from customers in the CAC payback - wouldn't you want to see how long an average customer should last in order to pay you back their CAC instead of netting it out with leaving customers?

[@financialmodeling]

People sometimes calculate CAC and LTV / CAC in different ways, but lost revenue is usually factored in because you want to account for the fact that some customers will cancel, sometimes very early, which means the payback period is longer because the company still spends money to acquire customers who cancel (especially if it happens early in the lifecycle).. If you only consider new customers, the CAC Payback Period might look "too good to be true" (such as only 2-3 months here - unlikely in real life).

[@pfknob]

Thank you. This is great! You said that we can download the spreadsheet. Where is the link?

[@financialmodeling]

Click "Show More" and scroll to the links below Resources.

[@pfknob]

@@financialmodeling Thank you!! Love your excellent videos.

[@JUQR1]

@@financialmodeling they are only KZbin links? What about the spreadsheet?

[@user-gp9eo7li6t]

Really helpful. I have seen varying definitions around how CAC is defined - looks like you are using a New Logo subset of S&M here which makes sense but don't you want to allocate the remainder as a cost of expansion - netting against LTV?

[@financialmodeling]

You typically look at new vs. existing customers separately in these calculations because it costs less to maintain an existing customer relationship. You could look at some type of combined ratio that includes the initial subscription + expansions over time and then deduct the S&M cost required to renew, but that would be different from the normal LTV / CAC metric.

[@sonerguney3225]

Very good. Can we have the excel file to download?

[@financialmodeling]

Thanks. Click "Show More" and scroll to the links under "Resources."

[@John-thinks]

What are "leads?" Thanks for the content!

[@ggas33dfdf]

A lead is a potential customer you can contact because he/she gave you the allowance to do so. Leads can be defined differently by industry. For example a lead in a SaaS business could be something different in comparison to a lead in manufacturing or financial service business. In terms of SaaS a lead is usually someone who showed interest in your product and signed up for a newsletter or a free trial for your product.

[@dbsk06]

@@ggas33dfdf THANK YOU! interview coming up :)

[@financialmodeling]

What Martin said below (thanks for responding). A lead is just a "prospective customer" from any source (email newsletter, phone, networking, website visitors, etc.). Enterprise-focused businesses always need to be generating leads, which they then speak to and hope to convert into customers eventually.

[@JUQR1]

I’m sorry but there is no link to the excel spreadsheet... am I missing something. Someone pls respond I’d love to get started using this outline.

[@financialmodeling]

Click "Show More" and scroll down to the links.

[@arthursitbon7109]

This video is very instructive :) Can we have the excel sheet pls ?

[@financialmodeling]

Click on "More" and scroll down to get the files.

[@John-thinks]

Can someone explain why LTV / CAC is useful at ALL? It seems like nonsense to me. Why are we not comparing LTV to total customer costs including both CAC and retention costs? You don't access the full LTV just with the acquisition cost. You need to pay to keep them too, right? Are we basically just assuming that the cost of switching becomes higher as you become more entrenched and thus retention costs are trivially low??

[@financialmodeling]

The answer is that the retention costs are even more difficult to determine than the initial acquisition costs. And yes, it costs something to keep each customer, but this is usually much less than the initial acquisition cost, especially if it's a product that's difficult to switch away from. LTC / CAC is mostly a metric that is useful in very broad strokes, i.e., if it's far below 1.0x, you know the company has a problem, but getting something in the 2.0x - 4.0x range doesn't mean much except for "it seems about normal."