The hidden ratio that will determine if your business lives or dies.

#17

This post is vulnerable. It was very uncomfortable to write.

I wrote it a month ago and kept it on the shelf, but finally decided to hit send.

It uses the actual numbers from when I launched and almost had to close my first business.

Hopefully my example can help you avoid or fix the same problem!

Because this explanation needs actual numbers to work, I’ve included a link at the end of the newsletter to a free calculator I made so you can plug in your numbers.

If you can nail the LTV:CAC ratio, you can cashflow your business and grow without stressful things like debt, credit lines or maxed out credit cards. It’s a little known ratio, but kind of a big deal.

A story

I started CappaWork in 2019. I am a very distractible person by nature and need lists to keep me on track. But I couldn’t find a business planner that I really liked. So I designed one.

I used all the techniques I’d learned as a product developer, created the beta product and used personal savings to order the first run. My wife and I put down $6,000 of our savings to launch.

At first it sold really well! Friends and family were very into it and word of mouth helped it to take off. Then once everyone I knew had heard about it, I turned to paid ads to generate new sales.

This is where it got dicey.

You probably know this already, but when you bring a customer into your business, there is a cost associated.

If it’s friends and family, that cost uses relationship capital. If it’s a stranger, you have to pay in some form to get in front of them. This cost could be in the time it takes to make social media posts, or the cost to rent a billboard, or to hire a Facebook Ads agency.

This is referred to as CAC, or “Customer Acquisition Cost.”

You also probably know this, but when you bring a new customer into your business you don’t want to just measure how much they initially pay you, you want to think about how much they might be worth your company over time.

This is called LTV or “Life Time Value” and is generally measured as “Average Order Value x Frequency of purchases”. (Remember our Profit Formula)

I sold a planner for $32 and people generally bought 2 a year. AOV of $32, Frequency of 2, LTV of $64. Because I was bootstrapping I only calculated LTV at a year.

With my $6000 investment, I could order 500 planners, at $12 a piece. I did all of the MBA math and said “sweet I can make $16,000 if I sell them all. That’s enough to reorder, get a better COGS deal and sell out those too.”

By these numbers, this business looks like it’s good to go.

However, they do not teach how to cashflow a business in business school.

That I had to learn the hard way.

The strategy, explained

There are many ways to build a business. Venture investment, crowd-funding, small business loans, traditional debt, credit cards - these are all ways that people have built very successful businesses.

I decided I wanted to build my business on cashflow (or bootstrapping) because I wanted to be in control of the scaling timeline.

After some early success with friends and family, it felt like time to use the proven DTC playbook and start paid ads. So, I found a recommended ad agency, paid them $3,000 to create ads and then another $1,500 of actual ad spend.

Crickets

Some traffic came in, but not nearly enough.

I did another month. Still crickets

The Customer Acquisition Cost was about $12 through ads.

And the CAC calculation did not include the $3000 per month retainer for the agency, it was just on ad spend (Note: when you look at Meta’s dashboard, the cost of the agency is never shown in the CAC, CPA or ROAS, and your agency probably won’t calculate it for your either, you have to connect those dots yourself).

I knew that if we kept at it, that cost would go down because the algorithm would target better, but rather than crossing my fingers and hoping for the best, I did my research.

Most business accelerators (like this one from Andreesen Horowitz) recommend an LTV:CAC ratio to be somewhere between 3 and 5. Specifically, the lifetime value of your customer should be 3-5 times what it cost you to acquire them. Having a 3:1 ratio works if you have cash to fund the acquisition of customers and then can keep them for a long time so they pay back the investment and then some.

With an LTV of $64, according to their math, I could spend up to $21 to acquire a customer. Technically my CAC of $12 was really good!

But when I looked at my bank account, I didn’t see a way to continue to fund ads AND be able to reorder more inventory.

What the heck was going on?

Seeing that I was within range according to experts, but also seeing that I didn’t have enough cash, I forecast cashflow for the coming 4 months.

It didn’t look good.

To create a forecast I made a guess about how many units I might sell. Then, I multiplied units by price to get revenue. Subtract out the cost per planner for fulfillment and shipping, but not COGS (remember I had already purchased them) and you get cashflow.

I saw that if I continued with a 3:1 ratio for ad spend, I’d be in debt.

If I kept a 5:1 ratio for ad spend, I wouldn’t be able to reorder more inventory with cash. I would need a credit line.

I kept playing with the ratios and it wasn’t until about 50:1 that things looked sustainable and — important for my family — peaceful.

I immediately cancelled my contract with the agency and stopped all paid advertising.

My business was broken and needed to be fixed before I could scale.

How to Fix it.

First I had to be really honest with myself. This was and still is very uncomfortable - embarrassing even.

In my roles before starting my own business I was responsible for a P&L of $3 million and CEOs of big businesses (like a Billion and up) paid the companies I worked for a lot of money to get my strategic analysis.

How could I have gotten something so simple so, so wrong? This business was a fraction of the size of ones I’d worked successfully on.

Did I have what it takes to be an entrepreneur?

The answer to the first question was that I dutifully followed the existing advice and was even in range, but something critical had changed. In the time between the initial DTC boom, and when I launched, paid acquisition got a lot more expensive. I wrote an in-depth take on this here.

Bootstrapped growth by paid ads was now nearly impossible - you needed baseline $50k to spend on ads before looking for a return.

To hit the the LTV/CAC ratio of 50:1, I either needed to reduce the CAC, or increase the LTV.

To get CAC to $1.28, that meant being very good at social media or creating a network effect. I am not good at social media. The product I made is very personal and has no network effect.

That left increasing LTV. But how could I get it to $1,800?

Quite simply, with my existing business I couldn’t. I needed a dramatic change.

This is where I had to answer the second question - Did I have what it takes to be an entrepreneur?

Fortunately there are a few things in life that if you will it to be so, it can be. Being an entrepreneur was still the best path for me and my family, so I willed it to be.

I put all of CappaWork on hold. No more ads, no more time spent on it. Existing customers could continue to buy, but I couldn’t put any time into it. I needed to figure out how to get to an LTV of $1,800.

That led me to almost a year of creating, testing, re-creating different services for entrepreneurs. I beta launched a program to do in depth profit analysis for $10k. No one bought.

I created a cohort bootcamp for $1k. People joined but didn’t finish.

Finally I landed on 1-on-1 coaching to help purpose driven entrepreneurs increase their profit, using their data. That one stuck 🙂 . That one is profitable. That one is Simple Strategies.

Now when I create new programs I start with this LTV/CAC ratio of 50:1. Am I guaranteed that it will be a success? No, but I’m guaranteed to not lose money on it. Which makes life as an entrepreneur peaceful.

I have a productized service launching soon for $1,999. Using the 50:1 ratio I know I can spend up to $40 per customer to help them buy.

I have a course launching soon teaching small business leaders how to use AI to increase profit for $150. I can spend $3 per customer for that product. Knowing that before I launch changes my entire strategy.

Conclusion

Starting and almost losing CappaWork was very humbling. The plan I initially made was reasonable, but wrong. I had to learn the hard way that if you’re going to bootstrap a business, you need to play by different rules.

One of the rules I think is critically important is having a very, very high LTV/CAC ratio.

Leave the super-stressful hyper-scaling to the VC backed entrepreneurs.

I prefer the peaceful path.

Catch you next week!

-Nate

Link to the LTV/CAC spreadsheet I used to fix my business.

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