The Reason Why Investors Obsess Over LTV/CAC (Higher Valuations)

High LTV/CAC ratios can lead to higher valuations.

It’s one of the most high-leverage metrics that astute PE and VC investors watch closely. 

Small improvements in this ratio can lead to disproportionate increases in financial outcomes.

But a higher LTV/CAC ratio doesn’t just make a business more profitable. It can also lift its valuation multiple.

This means that if a company acquires customers more profitably, then its relative valuation will be higher compared to a company with a lower LTV/CAC ratio.

Let’s break these ideas down.

1) LTV/CAC increases valuation

A blog post by a16z demonstrates how improving LTV/CAC from 2x to 3x (a 50% increase) can triple a company’s valuation.

Let’s consider how.

Operating expenses can be broken down into three buckets:

• General and Administrative (G&A)

• Research and Development (R&D)

• Sales and Marketing (S&M)

The a16z blog post suggests that when you take G&A and R&D as a percentage of Gross Profit (not Revenue), the differences in relative spend becomes smaller than when compared with revenue.

• G&A as a % of Gross Profit typically ranges between 12–17% and averages 14%.

• R&D as a % of Gross Profit typically ranges between 17–22% and averages 20%.

Because R&D and G&A expenses (as a % of Gross Profit) are relatively consistent across companies, S&M efficiency is what ultimately drives long-term profitability.

Think about it this way:

• S&M expense is your CAC.

• If G&A and R&D are stable across companies, then the efficiency of S&M spending determines how profitable you are.

• A higher LTV/CAC means that S&M (as a % of Gross Profit) is relatively lower (due to higher customer acquisition efficiency), resulting in higher Operating Profit (or EBITDA Margins).

• Higher EBITDA margins generally translate into higher valuations.

For example, if Company A and Company B both generate $100 million in revenue but have 10% and 20% EBITDA margins respectively, their EBITDA will be $10 million and $20 million. Assuming both trade at the same EBITDA multiple, Company B’s valuation would be twice that of Company A.

2)  A higher LTV/CAC increases the valuation multiple

The benefit of a higher LTV/CAC just increase the profitability of a business, it also drives a higher valuation multiple.

A company’s value is the present value of its future cash flows discounted at an appropriate rate.

The more profitable a company, the more cash it is able to generate over time. This means that companies with higher margins tend to have higher valuation multiples.

When you plot long-term operating margins against valuation multiples, the relationship between LTV/CAC, EBITDA Margins and valuation multiples become clear:

• Companies with 16% margins (roughly 2x LTV:CAC) trade at around 1.5x Gross Profit

•  Those with 33% margins (3x LTV:CAC) trade near 5x Gross Profit

• And those with 46% margins (5x LTV:CAC) reach almost 8x Gross Profit.

In short:

Higher LTV/CAC → Higher EBITDA Margins → Higher Valuation Multiple

As your LTV/CAC improves, margins expand, and the valuation multiple grows disproportionately larger.

A business that’s twice as efficient at acquiring customers isn’t just twice as valuable; it can be worth three to five times more.

This is Part 3 of my breakdown of the LTV/CAC ratio in my Metrics for Scale series.

In Part 1, I explained what LTV/CAC is and why it matters.
In Part 2, I broke down how it connects to profitability and growth efficiency.

Here in Part 3, we explored how LTV/CAC directly drives valuations.

I’m eager to get your thoughts on the most important metrics impacting your business!