CAC Payback Period

What is the CAC payback period?

CAC payback period is the number of months until a new customer's gross profit has covered the sales and marketing costs of acquiring that customer. In German it is called Amortisationsdauer der Kundengewinnungskosten, also CAC Payback or Payback-Dauer for short. It is calculated on a gross margin basis, that is, with revenue less the direct costs of service delivery (gross margin). If acquiring a customer costs EUR 3,000 and EUR 250 of the customer's monthly payment remains after direct costs, the acquisition costs are earned back after 3,000 / 250 = 12 months.

The metric links a company's unit economics with its capital requirement. Every new customer is pre-financed: the costs for sales and marketing are incurred before the customer pays and flow back only over the payback period. The metric is used above all for subscription software (SaaS) and other models with recurring revenue. In funding rounds, investors use it to assess the planned use of proceeds and the development of the burn rate and runway. The metric is not defined by law, so the method of calculation must be disclosed.

Calculating the CAC payback period: formula on a gross margin basis

Formula: CAC payback period in months = customer acquisition costs / (monthly recurring revenue per new customer × gross margin)

Customer acquisition costs (CAC) result from the sales and marketing costs of a period divided by the new customers won in that period. At company level, the same figure can be presented as the ratio of sales and marketing costs to the gross profit of newly won monthly recurring revenue (MRR).

The calculation does not work without gross margin, because only gross profit is available to repay the acquisition costs. The part of revenue spent on data centre, third-party licences and ongoing customer care does not flow back. Anyone who calculates without gross margin shortens the payback period by exactly that share. At a 60% gross margin, it appears 40% too short; twelve actual months become 7.2 months on paper.

Simple and cohort-based calculation

The basic formula assumes that every customer stays until repayment. In reality, some customers cancel before the costs are covered. The cohort-based calculation therefore sums the actual gross profit of an entry cohort month by month and sets it against the acquisition costs of that cohort. The payback period is the month in which the sum reaches the costs. With noticeable churn it comes out longer than under the basic formula, with strong expansion shorter (cohort analysis).

Benchmarks for the CAC payback period

Which payback period is sustainable depends on the customer segment, the contract term and churn. As a rule of thumb, the following guidance applies:

• Under 12 months: common benchmark for capital-efficient growth, above all in business with small and medium-sized customers.
• 12 to 24 months: often encountered in business with large customers, provided multi-year contracts and low churn secure the longer repayment.
• Over 24 months: needs explanation. Growth then ties up capital for a long time, and any deterioration in churn endangers repayment.

More important than the absolute value is the distance to the expected customer lifetime. By the simple formulas, the LTV/CAC ratio equals the quotient of customer lifetime and payback period. A payback period of 15 months is sustainable with a lifetime of five years, but hardly with a lifetime of 18 months.

Capital requirement and funding round

The payback period translates growth into capital requirement. Every new customer ties up its acquisition costs until its gross profit has repaid them. Anyone who grows faster wins more customers at the same time and ties up correspondingly more capital. A growing company with a long payback period therefore shows a high net cash outflow despite good customer metrics.

In the funding round, the metric is linked to the use of proceeds. From the planned number of new customers, the acquisition costs and the payback period, it follows which part of the capital flows into the pre-financing of customers and when it comes back. A shorter payback period reduces the capital requirement for the same growth or allows more growth with the same capital.

Prepayments and liquidity

The payback period on a gross margin basis and the return flow of liquid funds must be distinguished. Annual prepayments improve liquidity because the fee is received at the start of the contract. The acquisition costs are, however, covered in the first contract year only if the prepayment less the direct costs of that year is at least as high as the acquisition costs. If the prepayment is bought with a discount, the payback period on a gross margin basis lengthens at the same time, because the monthly gross profit falls.

The CAC payback period in due diligence

In due diligence, the payback period is recalculated from three sources. The sales and marketing costs by month come from bookkeeping, the recurring revenue per new customer from the billing system and the gross margin from a reconciliation of the income statement. Investors often additionally require the cohort-based calculation, because it includes churn and expansion.

The delineation is about whether costs and revenue belong together. If the sales costs also include the effort for expansion with existing customers, the expansion revenue belongs in the calculation, otherwise only the revenue from new customers. It must also be clarified whether revenue counts from contract signing or from the start of billing. Between the two there is often an implementation phase of several months in business with enterprise customers.

Through the delineation, the metric can be shortened without anything changing in the economics. Starting points are calculating on a revenue basis, leaving out personnel costs or the sales work of the management, a particularly favourable quarter and list prices instead of the fees actually billed. Reviewers therefore reconcile the stated payback period with the magic number. With an 80% gross margin and a magic number of 1.0, it is approximately 12 / (1.0 × 0.8) = 15 months.

Worked example: CAC payback period of property management software

A software company for property managers spends EUR 1.2 million on sales and marketing in the year and wins 200 new customers with it. A new customer pays EUR 500 per month, the gross margin is 80%, so the direct costs per customer are EUR 100 per month. Each month, 2% of customers cancel.

• Customer acquisition costs: EUR 1,200,000 / 200 = EUR 6,000 per new customer.
• Gross profit per customer and month: EUR 500 × 0.80 = EUR 400.
• Payback period under the basic formula: EUR 6,000 / EUR 400 = 15 months.
• Incorrect, on a revenue basis: EUR 6,000 / EUR 500 = 12 months.
• With churn: after n months, 0.98 to the power of n of a cohort remains. The cumulative gross profit per customer won is EUR 400 × (1 minus 0.98 to the power of n) / 0.02, after 17 months around EUR 5,814, after 18 months around EUR 6,097. The costs are covered only in month 18.
• Annual prepayment with a 10% discount: EUR 500 × 12 × 0.9 = EUR 5,400 at the start of the contract. After deducting the direct costs of the first year of 12 × EUR 100 = EUR 1,200, EUR 4,200 remain, which is less than the EUR 6,000 acquisition costs. Monthly gross profit falls to EUR 450 minus EUR 100 = EUR 350, and the payback period rises to 6,000 / 350 = around 17.1 months.

The example shows three effects. Without gross margin, the vendor appears to reach the common threshold of twelve months, although it misses it by a quarter. Churn lengthens the actual repayment by three months. The prepayment improves liquidity, but even from a liquidity perspective the costs are covered only with the payment for the second contract year. On a gross margin basis, the discount even makes the model less efficient.

Distinction: payback period, LTV/CAC ratio, magic number and break-even

• LTV/CAC ratio: compares the total value of a customer with its acquisition costs. The payback period describes how quickly the capital employed flows back.
• Magic number: measures sales efficiency at company level via the net increase in annual recurring revenue, including expansion and churn.
• Break-even: the point at which the whole company covers its costs. The payback period asks the same question for a single customer.

Common mistakes

• Calculation on a revenue basis. The payback period appears too short by the share of direct costs, at a 60% gross margin by 40%.
• Incomplete acquisition costs. If salaries, commissions or the sales time of the management are missing, the metric is artificially shortened.
• Contract signing instead of start of billing. If there is an implementation phase between signature and first invoice, the actual repayment lengthens by that time.
• One value for all channels. Referrals, paid advertising and field sales have very different payback periods. The average is not suitable for budget steering.
• Churn ignored. If the payback period is close to the average customer lifetime, a considerable share of customers never repay the acquisition costs.
• Liquidity and economics mixed up. Prepayments speed up the return flow of liquid funds but do not shorten the payback period on a gross margin basis.

Frequently asked questions

How is the CAC payback period calculated?

The customer acquisition costs are divided by the monthly gross profit of a new customer, that is, its monthly recurring revenue times gross margin. If acquisition costs EUR 6,000 and the customer brings in EUR 500 per month at an 80% gross margin, the result is 6,000 / 400 = 15 months.

What is a good CAC payback period?

As a rule of thumb, under twelve months is considered good, calculated on a gross margin basis. In business with large customers, 12 to 24 months is also accepted with multi-year contracts and low churn. What remains decisive is the relationship to the evidenced customer lifetime and the available financing. A company with a short runway tolerates a long payback period less well than one with secured financing.

How is the payback period calculated with usage-based pricing?

Best on a cohort basis. If a customer's revenue rises with usage only gradually, the basic formula with the initial revenue gives a payback period that is too long, and with the later revenue one that is too short. The cumulative calculation per cohort reflects the increase correctly.

Does a set-up fee belong in the calculation?

It can be taken into account to the extent that a gross profit remains after deducting the implementation costs. This is then deducted from the acquisition costs before dividing by the monthly gross profit. The fee must not be treated as recurring revenue.

The Roemer Capital view

We measure the CAC payback period against the benchmark of under twelve months, calculated on a gross margin basis and separated by sales channel. If a client is above it, that is no reason for exclusion, but it is a point that we explain before talks with investors and back with concrete measures.

In the financial model, we link the metric to the use of proceeds of the round. From this it follows how many new customers are pre-financed with the capital raised, when their gross profit flows back and how long the runway lasts under these assumptions. As fractional CFO, we set up the monthly calculation so that it appears in the same delineation in every investor update, the regular report to the investors.