You’ve got a killer idea, some initial financing and have seen great market acceptance. Now you need a financial plan to become a scalable and viable company before you can get additional funding. Before your eyes glaze over, rest assured I will keep this high level and just call out the initially important financial metrics to watch (and those your investors will be watching).
CAC, Payback Period and CLV, a Primer
Have you ever wondered why some of the largest subscription companies have yet to show a profit? They keep getting round after round of funding yet are still in the red. The answer lies in their close attention to a few key metrics.
Everyone knows customer acquisition is expensive. In the subscription business model, it is imperative that you keep your churn rates down in order to recoup this initial expense. Right out of the gate, you need to track 1) CAC 2) Payback Period and 3) CLV.
By knowing your Customer Acquisition Cost (“CAC”), your Gross Margin (“GM”) and Average Revenue per Account (“ARPA”), you can understand your Payback Period (“PP”). This is the time you must keep your average customer on your platform to just break even on the investment you made to acquire them.
Work to minimize this payback period by decreasing CAC or increasing GM and/or ARPA. Best practice is to keep your payback period under a year. While ARPA may be harder to change on a new customer, you can find more efficient ways to attain customers which will decrease your CAC and increase your GM.
After minimizing your payback period, you need to focus on retaining clients and maximizing Customer Lifetime Value (“CLV”). A good rule of thumb is to have CLV be three times (or more) greater than your CAC. To calculate your average customer CLV, simply use your ARPA, GM and Churn Rate.
Work to maximize CLV by increasing ARPA (through cross and upsells), increase Gross Margin through efficient processes and reduce your churn rate by driving value with proactive customer success programs.
In the end, subscription model financing really comes down to one thing: cash flow. This brings us full circle and back to why many successful and well funded SaaS companies have yet to show a profit. These companies have solid financial metrics that will result in long-term viability and profitability. Their investors know fast growth necessarily requires short-term losses, but that these losses will be recouped as long as these key financial metrics remain in good health.