3 metrics that matter when looking for investment
20 May 2016
If you’re at the point where you’re looking for investment, you should be all over your numbers; forecasts, margins and cash requirements. The typical investor will be focused on the scalability of your business, i.e. what is the potential market?
However, they will also be very interested in how much it costs to bring customers to your business in that market, and how much you expect to make from those customers. In other words:
- Customer acquisition cost (CAC)
- Lifetime value of a customer (LTVc)
- Forecasted cash burn (FCB)
These metrics tell any investor (and importantly those managing the business) if there is a foreseeable future for the business. We always hear ‘cash is king’, and it most certainly is...up to a point.
If a company is to have any sort of lifespan other than just consuming cash, the business needs to make more money with each customer than it costs to find them and encourage them to buy.
“The greater the gap between the CAC and the LTVc, the better the business model looks.”
If a business has some form of history, then internal data is the best way to calculate CAC and LTVc. Some businesses — particularly early stage — may struggle when calculating LTVc, as the full life cycle of a customer may not have been realised.
In this case assumptions need to be made, either from external data or derived internally, i.e. competitors or market data. So, how do you calculate each of these and what do they really mean?
Customer acquisition cost (CAC)
Customer acquisition cost is the cost of acquiring a transacting customer. A transacting customer has exchanged either cash, vouchers, gift cards, or a combination of these for the product or service.
CAC = Total cost of customer focused advertising / No. of transacting customers
For example, if we spent a total of £5,000 and gained 420 transacting customers:
CAC = £5,000 / 420 = £11.90
These types of focused advertising costs will vary depending on business and sector. Some typical channels include Facebook adverts, referral marketing, Twitter adverts, physical mailshots, TV, AdWords, Instagram adverts, and cold calling.
CAC by channel
An investor (and a management team) should be interested in diving deeper into this and calculating the CAC by channel. This more insightful piece of management information can be tracked, reported on and used to continue lowering the cost of acquisition. Let’s take the example of using Facebook and Twitter as different channels to acquire customers.
We spent £2,500 with Facebook and had 350 transacting customers:
CAC (FB) = £2,500 / 350 = £7.14
We spent £2,500 with Twitter and had 70 transacting customers:
CAC (Tw) = £2,500 / 70 = £35.71
Straight away, you can see the £11.90 we calculated across all channels above is hiding an underperforming channel with a CAC of £35.71.
This could be due to customers not using this channel, the ad format, or competitors on that platform. Whatever the reason, we could significantly drive a lower CAC by focusing on a different channel to acquire customers.
Lifetime value of a customer (LTVc)
Lifetime value of a customer (LTVc) is the gross margin made before they stop using your service or buying any products. Businesses that sell a product should only be interested in the gross margin when calculating the value of a particular customer group.
In some businesses, revenue appears to be the driver to calculate LTVc. However, this is only because there are no direct costs relating to servicing that specific customer group, i.e. in a SaaS (Software as a Service) based model. In these businesses, revenue actually equates to gross margin because there are no direct costs. So I would remove any voucher you have provided them as an incentive to buy, which is often the case i.e.:
Margin = revenue - less direct costs - voucher
LTVc = Year 1 gross margin + ((Year 2 gross margin x (1 - attrition rate)) + … + (Year n gross margin x (1 - Year n attrition rate))
(n = the number of years you expect them to be customers)
- Product typically has a two year span with a customer
- £25 voucher given to new customer
- Average annual product sale is £50
- 25% of customers lost after year 1 (or 75% of customers repeat-buy in year 2)
- Customers not tracked beyond year 2
- 60% gross margin (i.e. our product costs us £20)
LTVc = ((£50 - £20) - £25 voucher) + ((£50-£20) x (1 - 0.25)) = (5.00 + 22.50) = £27.50
Now you have both of these metrics, calculate the difference. LTVc needs to be greater than CAC otherwise, all things being equal, the business has no future in my opinion. The greater the difference, the more money you can make out of acquiring a customer, relative to the cost of finding that customer.
Using our Facebook example above, we can see:
LTVc - CAC (FB) = £27.50 - £7.14 = £20.36
It’s even more interesting to delve deeper into the LTVc by channel. Your Facebook customers may have different characteristics to other channels, for example a lower attrition rate. This would then prove a more analytical tool to truly understand which channel to market within.
Forecasted cash burn (FCB)
Forecasted Cash Burn (FCB) is the amount of cash which is used on a monthly basis (especially important for startups). This can sometimes be turned into Cash Zero Date, which is the date at which you expect (based on forecasted cash burn) you will run out of cash. In other words, FCB is how long you can continue in business before you need a further injection of cash.
The most important thing with metrics and management information is that they give you the insight to continuously tweak and improve your customer acquisition strategy.
Taking the time to investigate the data behind these metrics — and using what the numbers are telling you to adjust your strategy — can mean getting the right investor at the right terms, and at a time when your business is looking its strongest.
Alastair Barlow leads PwC’s My Financepartner team in London and the South East, a cloud-enabled accounting and business support service that lets ambitious SMEs grow.