CAC, LTV, ARPU, EBITDA… for most people, these terms sound suspiciously like a bunch of letters that came out of a bowl of alphabet soup. However, for the angel investors and venture capitalists who invest in early-stage startups, these are terms that refer to some of the financial metrics they examine most closely when deciding to invest in a company… or not.
Unfortunately for founders who haven’t been reading financials since they were knee-high to an Excel spreadsheet, all these terms can make your head spin faster than a failing startup churns customers (but more on that later!).
Now, each startup’s business is unique and each will have a few financial indicators that are specific to that business. However, some financial metrics are extremely common and play a significant role in discussions with investors across businesses.
So before you sit down with an investor and ask them to write you a check, here are seven financial terms you need to know, and why they’re important:
1. CAC
This is a metric you need to have down cold and circled in your financials. That’s because one of the first questions almost every investor I know asks is “So what’s the CAC?”
CAC stands for Customer Acquisition Cost and it measures what you’re spending to acquire your customers (i.e. the effectiveness of your marketing). Investors want to know how many customers you can bring onboard for every additional dollar they may be adding to your marketing budget.
Now because of that, you may be asked specifically for “Paid CAC” (CAC that is based solely on paid marketing) or whether your CAC number is “blended” (includes customers acquired organically). Paid marketing is scalable, while organic customer acquisition (while nice!) usually isn’t. You should be familiar with both when speaking to a prospective investor.
2. LTV
LTV stands for Lifetime Value of a Customer, and it’s the flip side of CAC. With CAC, you measured how much it costs to get a customer. With LTV, you are measuring how much that customer will eventually spend with you. The ratio between your LTV and your CAC is important.
LTV can be both Gross or Net. Gross LTV is based on the total revenue a customer brings in over their lifespan, while Net LTV is based on the profit generated. LTV can also be broken down among different segments of your customer base to assess whether specific groups of customers may be more valuable than others, especially in comparison to CAC.
3. ARPU
ARPU stands for “Average Revenue Per User” and measures the value of the users on your platform. ARPU is calculated by dividing total revenue by the number of users for a specific time period (eg annually, monthly, etc).
This metric is especially helpful when you have users who may be generating revenue beyond what they directly spend as customers. For example, if you have a subscription business but also generate revenue through advertising and sponsorship, ARPU can be a very meaningful metric for your business.
4. Churn Rate
The Churn Rate measures how fast you are losing customers, and is calculated as the percentage of customers who stop doing business with you over a period of time.
Churn Rate is critically important. First, it’s important because losing customers is expensive. If customers are constantly churning out, it will mean you have to constantly spend more in customer acquisition to continue to make money.
But it’s also important because your Churn Rate is a strong indication of customer satisfaction. To investors, a high Churn Rate indicates customer dissatisfaction with the product service, the customer experience, or both, so they really want to see that you have a good handle on this metric and can keep it under control with happy customers.
5. Active Users
First-time founders often walk into investor meetings armed with a set of historic metrics such as “downloads” or “registrations,” only to be asked “But how many active users do you have?”
The reality is that investors don’t really care about how many users have ever been on your platform. What investors really care about is how many users are engaged. They want to know how many of your users are active because it’s your users who actively interact and engage who ultimately drive revenue.
This is usually expressed as Daily Actively Users (DAU), Weekly Active Users (WAU), or Monthly Active Users (MAU).
It’s important to note, though, that there is no uniform set of parameters used to define an “active user,” so you’ll need to think through and define what “active” means to your business whether it’s daily logins, photos shared, comments, or something else. Whatever you use to define your “active users,” be ready to discuss it with investors who will want to deep dive into your thinking.
6. EBITDA
“EBITDA” stands for “Earnings Before Interest, Taxes, Deprecation & Amortization“. While that is a mouthful, EBITDA one of the most common and useful metrics to gauge a company’s operating performance because it takes out financial considerations like depreciation on capital investments and interest payments on debt.
Because of that, EBITDA is a helpful measure of the cash flow coming from a company’s operations. If you’ve had to sink a lot of money into capital investments for your startup, for example in buying machinery or developing a platform, investors are very likely to ask about your EBITDA as they try to get a sense of whether your business model works or not.
7. Burn Rate
Burn Rate, in short, is the rate at which you are depleting (or “burning”) your cash. For most startups who are spending cash but not yet generating much, if any, revenue, the Burn Rate measures the negative cash flow.
Burn Rate is usually described in cash spent per month. That Burn Rate per month is then used to calculate the “runway”, which is how long a startup can continue to spend at that rate before running out of money.
It’s important to note that a higher Burn Rate is not necessarily a bad thing. After all if your Burn Rate was very low, you probably wouldn’t need to ask for money at all. What’s important is that the cash is being spent to grow the business so it can achieve a big return on investment because that’s what investors really want to see.
So there you have it!
Keep these metrics in mind as you prepare your financials and projections, and you’ll be prepared for some of the most important questions investors will ask about your startup.
