ACV (Annual Contract Value)

What is ACV?

ACV (annual contract value) refers to the value of a single customer contract, expressed per contract year. For a monthly contract it equals twelve times the monthly fee, and for a three-year contract it equals the value of one contract year. Unlike ARR, ACV does not describe a company's entire contract base but a single contract or, as an average, a group of new deals.

ACV is used mainly in sales and planning. Sales management uses it to calculate commissions and to assess open sales opportunities in the sales pipeline. In the financial model, planned new business results from the number of deals multiplied by the average ACV per customer segment. In investor discussions, a rising average ACV of new customers serves as evidence that a company is winning larger customers. There is no binding definition, and in practice two readings are widespread.

Calculating ACV: two readings

Formula: ACV = recurring fees of one contract year; in the broader reading ACV = TCV / term in years

Recurring ACV

In the narrower reading, ACV comprises only the recurring fees of one contract year, that is, subscription, ongoing add-on modules and contractually agreed maintenance. Set-up, training and one-off consulting are left out, while ongoing service flat fees with a fixed term are included. In this reading, ACV equals the contract's contribution to ARR and can be reconciled directly to the contract base.

ACV including one-off fees

In the broader reading, the total value of the contract (TCV), including one-off fees, is divided by the term in years. This reading shows what a contract brings in revenue per year on average, but it mixes recurring and one-off components. Anyone using it shows the share of one-off fees separately.

Tiered pricing and monthly contracts

If the fee rises contractually from year to year, the average view gives a different value from the current contract year. Both values are permissible as long as it is clear which one is meant. For contracts that can be terminated monthly, ACV is a calculated figure: twelve times the monthly fee describes the annual value if the contract continues unchanged, not a contractual commitment for twelve months.

Contract value, revenue and cash flow

ACV is neither revenue nor a cash receipt. Under commercial law, revenue arises only once the service has been performed; subscription fees are therefore recognised as revenue pro rata over the service period. How a set-up fee is to be treated depends on whether the set-up constitutes a separate service for the customer or merely prepares its use. This question is to be answered in the annual financial statements, not in the sales metric. If the annual value is invoiced and paid in advance, the liquidity flows in immediately. The portion not yet earned is reported at the balance sheet date as deferred income, that is, as an adjustment item for payments whose service is performed only after the balance sheet date.

For liquidity planning, the payment method therefore matters alongside ACV. A contract with an ACV of EUR 36,000 that is invoiced and paid annually in advance ties up no capital at the provider. The same contract with monthly invoicing and 30 days' payment terms leads to ongoing receivables, even though contract value and revenue are the same.

ACV and the sales model

ACV determines which sales effort pays for itself. The costs of winning customers (customer acquisition cost, CAC) must flow back from the contract's gross profit, that is, from revenue less the direct costs of delivering the service. How high this gross profit is depends on the annual value and on the gross margin. As a rough rule of thumb in practice:

• Annual values in the low four-figure range: deals are closed predominantly without personal selling, through sign-up and purchase within the product (product-led growth).
• Higher four-figure and five-figure annual values: selling from the office by telephone and video conference (inside sales) is common, with few meetings per deal.
• Six-figure annual values and more: field sales with on-site meetings, several participants on the customer side, tenders and sales cycles that often last several months.

The boundaries are fluid and depend on gross margin, contract duration and the complexity of the product. The yardstick is whether the acquisition costs pay back within a reasonable time (CAC payback period). A field sales force that sells contracts with a low ACV consumes more liquidity than the customers won bring back.

Contract size in valuation and due diligence

Revenue multiples are applied to ARR, not to ACV (revenue multiple). ACV nevertheless affects the valuation indirectly: a rising average ACV of new deals indicates a product that resonates with larger customers. A broad spread of contract values reduces dependence on individual customers, while a concentration of a few large contracts increases it.

In due diligence, a sample of contracts is drawn and the annual value agreed there is compared with the value in the sales system, the invoices and the cash receipts. It is also checked whether the pitch deck, financial model and customer list use the same reading, whether discounts in the first contract year have been taken into account and whether special termination rights shorten the term.

Worked example: ACV and payback of acquisition costs

An enterprise customer concludes a three-year contract on 1 January. The annual fee is EUR 36,000 and is invoiced annually in advance, and in the first year a set-up fee of EUR 12,000 is added. Sales and marketing costs of EUR 27,000 were incurred for the deal, and the gross margin on the subscription is 80%.

• Total contract value (TCV): 3 × 36,000 + 12,000 = EUR 120,000
• Recurring ACV: EUR 36,000, which is also the contribution to ARR; EUR 3,000 per month
• ACV including one-off fees: 120,000 / 3 = EUR 40,000
• Invoice amount in the first year: 36,000 + 12,000 = EUR 48,000, and EUR 36,000 in each following year
• Monthly gross profit from the subscription: 3,000 × 80% = EUR 2,400
• Payback of acquisition costs: 27,000 / 2,400 = 11.25 months

With the ACV including one-off fees, the result would be a monthly gross profit of around EUR 2,667 and a payback after around 10.1 months. The calculation looks more favourable even though the set-up causes its own costs and does not recur. The recurring ACV is therefore the more reliable basis for the profitability of customer acquisition. At 11.25 months, the payback is just under the common rule of thumb of twelve months; a discount of 10% on the annual fee would already extend it to 12.5 months.

Distinction: ACV, TCV and ARPA

• TCV: the value of a contract over its entire term, including one-off fees. ACV is its annual value.
• ARPA: the average recurring revenue per customer across the entire base. A customer can hold several contracts whose ACVs combine in ARPA.

Common mistakes

• Readings mixed. If ACV is formed including one-off fees and then reported as ARR, recurring revenue appears higher than it is.
• Monthly contracts presented as annual commitments. Twelve times a terminable monthly fee is an extrapolation. The share of committed and terminable contracts is shown separately.
• Only the average. An average ACV of EUR 40,000 can arise from two large customers and many small contracts. Only the distribution shows which customer segment carries the business.
• First-year discounts ignored. If the list price is used instead of the agreed price, ACV deviates from the invoices, and the deviation is noticed at the first contract reconciliation.
• Sales planned without reference to ACV. A financial model that provides for personal selling for contracts with a low annual value does not add up, regardless of the quality of the product.

Frequently asked questions

How is ACV calculated?

From the recurring fee of one contract year: monthly fee times twelve, annual fee unchanged, and for multi-year contracts the value of one contract year. If prices rise, the average over the term or the value of the current year is to be stated. With annual fees of EUR 30,000, EUR 36,000 and EUR 42,000, the average ACV is EUR 36,000, while EUR 30,000 enters ARR in the first year.

What is the difference between ACV and ARR?

ACV is the annual value of a single contract, while ARR is the sum of the recurring annual values of all running contracts at the reporting date. A contract has its ACV as soon as it is signed but enters ARR only when the term begins. A contract signed in October with a start in January therefore counts towards October's new business but raises ARR only in January.

Which reading do investors expect?

There is no fixed expectation. What matters is that the definition is stated and applied consistently. The recurring reading has the advantage that it can be reconciled to ARR without conversion.

What is a good ACV?

There is no generally good value. It depends on the relationship to acquisition costs and to customer retention. A low ACV can be economical if sales are largely automated. A high ACV is not economical if each deal costs more than the customer brings in over the contract term.

The Roemer Capital view

When planning new business in the financial model, Roemer Capital sets the number of deals and the average ACV per customer segment separately. This makes it possible to show whether growth is meant to come from more customers or from larger contracts, and both assumptions can be tested against past deals.

At the same time, Roemer Capital checks whether the planned sales organisation fits the ACV. As a benchmark, it uses a payback of acquisition costs of under twelve months and a ratio of customer value to acquisition costs of at least 3 to 1 (LTV/CAC ratio). If a plan lies well outside this, Roemer Capital discusses it with the management before investors raise the question.