CAC and LTV Due Diligence

Beyond profit, the two most important metrics in buy-side due diligence are Customer Acquisition Cost (CAC) and Customer Lifetime Value (LTV). Simply put: the higher the LTV:CAC ratio, the higher the profit — and the higher the valuation. Nearly all sophisticated investors use this ratio. So should you.

LTV

Lifetime Value

CAC

Acquisition Cost

Industry Benchmark

3:1

For every $1 to acquire, return $3 in lifetime value

So why don't more people discuss LTV:CAC during due diligence? Because it's hard to measure in a lower-middle market business that may not routinely track these metrics. Most diligence time is spent on legal, Quality of Earnings (QOE), and lender underwriting. If the DD period is 60–90 days, there's little time left for core metrics work — and that's a shame. You may not know if you're getting a deal or taking on exposure. Whether the previous owner left money on the table or maximized opportunity. Whether you're buying a platform to build on or a turnaround.

What we can say with certainty: you want to know the LTV:CAC ratio before signing acquisition documents.

How to Calculate LTV:CAC

Calculating LTV — Important First Rule

Never use Revenue to calculate LTV. Revenue generates misleading data and can lead to poor decisions. We also recommend against using Gross Profit alone. Our preferred metric is Contribution Margin — calculated as Revenue minus all Variable Costs (including COGS). This gives the most accurate picture of what a customer relationship is actually worth.

LTV for Non-Recurring Revenue Businesses

Step 1 — Purchasing Frequency

365 ÷ (Total Purchases in Last 365 Days ÷ Total Customers in Last 365 Days)

Note: Count each customer purchase occasion as one, regardless of how many items were in the order.

Step 2 — Define Your Date Ranges

Second Date Range: From (Today − Purchase Frequency × 3) to Today

First Date Range: Start of Second Date Range back by one Purchase Frequency period

Step 3 — Average Customer Lifespan (ACL)

1 ÷ ((First Date Range Customers − Customers Retained in Second Date Range) ÷ First Date Range Customers)

Step 4 — LTV

ACL × (Last 365-Day Contribution Margin) × (# of Customers in Last 365 Days)

Calculating CAC

CAC Formula

(Marketing Expenses + Sales Expenses + Fixed Sales/Marketing Overhead) ÷ Number of New Customers

Critical: Include total Sales and Marketing salaries — not just campaign spend. The full cost of acquiring customers must be captured.

Why This Ratio Is So Important

An LTV:CAC ratio of 3 is the widely-accepted benchmark because it signals efficient returns on sales and marketing spend. It means the company retains customers and has capacity to reinvest in its products and services. Companies with higher LTV:CAC ratios operate better, are less risky, and command higher valuations — because buyers can see the engine working.

Note: Most LTV:CAC content is written for recurring-revenue businesses. But the ratio applies equally to non-recurring revenue businesses. Even for single-purchase businesses, you should know if customers are being acquired efficiently and generating enough value.

How to Measure LTV:CAC With Limited Data

In the lower-middle market, there's a strong chance LTV:CAC isn't being tracked. But data usually exists somewhere — you just have to find it:

If a CRM is in place — even a basic or homegrown one — sort through it during diligence to assess customer acquisition and retention patterns.
If the P&L is clean, check spend line items in the accounting ledger (QuickBooks, etc.) to isolate sales and marketing costs.
If there's no CRM, pull purchase orders or client engagement records from sales receipts. Normalize the data in Excel. Even a rough baseline tells you something important.

How to Use LTV:CAC in Due Diligence

The most direct application: determine whether the business is undervalued or overvalued. If a company carries a 5× valuation multiple but its LTV:CAC ratio is 2, it's likely overpriced. If the ratio is high and the multiple is low, you may be looking at a real deal.

Beyond pricing, use the LTV and CAC data to identify post-acquisition opportunities — especially around repeat purchases and upsells. If the average customer makes five lifetime purchases, look at every customer who's made fewer than five. Model what increasing their purchase frequency does to revenue and margin. Then model upsell potential on top of that. This is where the real opportunity often lives.

Why LTV:CAC Must Be a North Star Post-Close

Post-acquisition, the same due diligence you conducted will eventually be conducted on your business by a future buyer. If you start measuring LTV:CAC from day one, you can chart its trajectory across your entire ownership period — and build goals and initiatives against it.

We'd go so far as to say LTV:CAC should be reviewed at every operating meeting and board meeting. Every team member with budget authority should understand it and be thinking about ways to improve it. This applies to both recurring and non-recurring revenue businesses. Regardless of model, the goal is the same: customers staying longer and being acquired more efficiently.