CAC payback tells a growth investor how long each new dollar of recurring revenue drains cash, and the same quarter can report four different answers.
CAC payback is the number of months of gross profit from newly won recurring revenue it takes to repay the sales and marketing spend that won it: prior-quarter S&M ÷ (new ARR × gross margin) × 12. On an illustrative quarter with 6.0 million of S&M, 4.8 million of new ARR and a 75 per cent gross margin, payback is 20.0 months. The same quarter reports anything from 15.0 to 26.7 months depending on the definition, which is why the definition has to be asked for first.
Worked in full in The Growth Equity Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
For a growth investor, CAC payback answers the question behind every subscription business plan: how long is each new dollar of revenue a cash drain before it starts paying for the next one? A company that pays back in a year can fund much of its own growth. One that pays back in three years needs outside capital for every point of growth it shows, and its valuation depends on that capital staying available.
| Input | Value |
|---|---|
| Sales and marketing expense, prior quarter | 6.0 |
| New-logo ARR signed this quarter | 3.6 |
| Expansion ARR from existing customers | 1.2 |
| Gross new ARR | 4.8 |
| ARR lost to churn and contraction | 0.8 |
| Net new ARR | 4.0 |
| Subscription gross margin | 75% |
Spend is lagged one quarter because deals signed this quarter were mostly generated by last quarter's pipeline. Where sales cycles are longer, lag further.
CAC payback (months) = S&M of prior quarter ÷ (new ARR in quarter × gross margin) × 12
Equivalently: 12 ÷ (sales efficiency × gross margin), where sales efficiency = new ARR ÷ prior S&M
In Excel: =SM_Prior/(New_ARR*Gross_Margin)*12
Each quarter's 4.8 million of new ARR produces 4.8 × 75% = 3.60 million of gross profit a year, or 0.30 million a month. Repaying 6.0 million at 0.30 a month takes 6.0 ÷ 0.30 = 20.0 months. Sales efficiency is 4.8 ÷ 6.0 = 0.80, and 12 ÷ (0.80 × 0.75) gives the same 20.0.
| Definition | Numerator | ARR used | Margin | Payback |
|---|---|---|---|---|
| Revenue basis, gross new ARR | 6.0 | 4.8 | 100% | 15.0 |
| Gross margin basis, gross new ARR | 6.0 | 4.8 | 75% | 20.0 |
| Gross margin basis, net new ARR | 6.0 | 4.0 | 75% | 24.0 |
| Gross margin basis, new-logo ARR only | 6.0 | 3.6 | 75% | 26.7 |
The revenue basis is the flattering one, and it is wrong in principle: S&M is repaid out of gross profit, not revenue, because the cost of serving the customer is spent before anything is left. The net new ARR basis is what a magic number produces: 4.0 ÷ 6.0 = 0.67, and 12 ÷ (0.67 × 0.75) = 24.0 months. It charges this quarter's churn against this quarter's acquisition, which is conservative but mixes two different questions. The new-logo basis is right when the S&M line is overwhelmingly spent on acquisition and expansion is driven by a customer success team budgeted elsewhere.
Match the numerator to the denominator. If expansion ARR is in the denominator, the cost of the account managers who sold it must be in the numerator. If it sits in cost of revenue or G&A, the 20.0 months is borrowing a cost from another line.
Billing terms change the cash picture without changing the metric. A customer who pays a year upfront hands over the whole first-year ARR on signing, so the cash payback is far shorter than 20.0 months even though the economic payback is the same. Diligence should report the gross margin payback as the unit-economics figure and treat upfront billing as a working capital benefit, which it is, rather than as evidence of efficient selling.
| Sales efficiency | GM 60% | GM 75% | GM 85% |
|---|---|---|---|
| 0.6 | 33.3 | 26.7 | 23.5 |
| 0.8 | 25.0 | 20.0 | 17.6 |
| 1.0 | 20.0 | 16.0 | 14.1 |
Payback is inversely proportional to both drivers, so a 60 per cent margin business needs a quarter more sales efficiency than a 75 per cent one to report the same number. That matters when comparing a pure software company with one that bundles services or payments: the services-heavy company's revenue-basis payback looks similar, and its true payback is a quarter longer.
State the formula with the number: prior-quarter S&M over new ARR times gross margin, times twelve, with the ARR definition named. Then recompute on net and on new-logo ARR to see the range, here 15.0 to 26.7 months for one quarter. The working documents in the free companion files for this book include a readiness screen that reports each unit-economics metric as reported and as rebuilt, which is exactly the habit this requires. For the retention side of the same business, see how to calculate net revenue retention, and for how growth and margin combine, the Rule of 40.
Gross margin. Sales and marketing spend is repaid out of gross profit, after the cost of serving the customer. On an illustrative quarter with 6.0 million of S&M and 4.8 million of new ARR, the revenue basis gives 15.0 months and the 75 per cent gross margin basis 20.0. At a 60 per cent margin the same efficiency gives 25.0 months.
Payback in months equals 12 divided by the magic number times gross margin, when the magic number is net new ARR over prior-quarter S&M. In the illustrative case, 4.0 of net new ARR on 6.0 of spend is a magic number of 0.67, and at a 75 per cent margin that is a 24.0-month payback.
Payback is how long repayment takes; LTV to CAC is how many times the spend is eventually repaid. With 4.8 of new ARR at a 75 per cent margin and 13 per cent of revenue lost each year, a simple undiscounted LTV is 27.69 against 6.0 of spend, about 4.6 times, and the 20.0-month payback uses 22 per cent of an implied 7.7-year life.
This article is one calculation from The Growth Equity Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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