The Silent Advisor Killer …

One equation to rule them all

A simple equation governs the success of any business

money burning

LTV – CAC > 0.

Violate this rule and your advisory business dies.

CAC= Cost of Acquiring Clients. It’s less understood than LTV (Lifetime Value of a client) but it governs your fate as an advisor and is responsible for 4/5ths of new advisors washing out of the business.

Yes, over ⅘ of Financial Advisors don’t make it 5 years in the business. Most of the remaining Financial Advisors earn less than $70K. Given the number of hours advisors work in the early days, that starts to feel like a Barista job at Starbucks. CAC is the thing killing or at least dramatically holding back your financial practice. CAC (in $ and TIME) is holding you back and I already feel you dismissing it.

But I don’t spend money on marketing …

You’re saying, “I don’t spend any money on marketing, so this doesn’t apply to me” or “All my clients are referrals, they don’t cost me a thing.”

That’s crap.

If it were true you would have an infinite number of clients. The truth is your time is limited and, since time is what you’re spending, it imposes both an opportunity cost and an upper limit on firm growth.

How do you calculate/measure CAC?

CAC is actually a pretty simple concept that, once you understand, will change the way you look at your business.

“If you cannot measure it, you cannot improve it”

– Lord Kelvin

 

The Formula to measure CAC is:
CAC = Total cost of Sales & Marketing / Number of New clients

Cost of sales and marketing should include ALL marketing expenses, including any time spent (valued at an appropriate hourly rate). Answer these questions:

Looking at 2012, how many new clients did you bring on?
How much did you spend in $?
How much did you spend in time?

Here is a simple example:

Acquired 10 new clients in 2012. Not bad.

Spent $5,000 on 4 events. All ads (Yellowpages, email marketing, etc) totaled $2,500. Logo material $2,100.

Spent avg of 10 hours per month on networking and other marketing. Value at $100/hour, $12,000.

Total Sales and Marketing = $21,600 / 10 new clients, CAC = $2,160

Whoops, you went backwards in 2012

Why? We need to give CAC a little more context. Let’s further say that on average these clients move $200,000 to your practice, you invite them to your client portal, and they move the money on January 1, 2012 … Now you see where I’m going.

You just earned a total of $20,000 that you spent $21,600 to get. You lost $1,600 on new client acquisition in 2012.

Oh it’s real …

There you go back-pedaling, thinking your time wasn’t a “real” cost so you made money. It’s not the way to run a business, but even if we pretend that’s okay, there is another problem.

You spent your time and money upfront and are getting paid back over time. For you accounting nerds, this is a working capital problem. You need to “finance” that gap one way or another. In the end, CAC really matters whether we’re talking about hard or soft costs.

So what is your CAC (cost of customer acquisition)? How does it compare to your first year revenue?

Let me know in the comments and we’ll see what we can do to help.









Also published on Medium.

John Prendergast John Prendergast is the co-founder and CEO of Blueleaf. He serves on the board of WiredTiger, a developer cloud optimized databases. He is also the founder and organizer of the Lean Startup Circle Boston. In addition to his decade and a half as an entrepreneur, John spent nearly a decade as an investment banker and financial advisor.
  • Stefan

    Why isn’t it LTV – CAC > 0 ? If CAC – LTV > 0, then it’s not worth acquiring customers.

  • Jason Wenk

    Yellow pages are probably not a good place to spend money promoting an event 😉

    • Funny. Of all the people I know, you may be the ONLY one who knows the answer to this question for your advisory business. We should teach folks how you’re doing that.

  • Guest

    If LTV = Lifetime value of a client, why are you only looking at their value in the first year?

    • This is a great question. 

      The short answer is business viability. The longer answer is that you want to think about the relationship of CAC to LTV and payback period. You generally want the payback period to be as short as possible be certainly shorter than 1 year. Otherwise your working capital needs get big fast.The general rule of thumb for these relationships is you want CAC to be paid back in less than 12Mo and you want LTV to be at least 3x CAC.The good news is generally if you’ve got a fee for assets arrangement you’re well beyond the 3x CAC. So I just focused on the other comparison.We’ll do additional posts about creating a balanced business model and about how to calculate and manage LTV

      • Guest

        From your example, one has to assume we are talking about a recurring revenue (1% fee ) model.  Assuming an advisor has a viable book already ( ie made it past the first 5 years ), then they can afford to pay $21,600 for a recurring revenue of $20,000. In fact, I’d be more than happy to do that all day long.  That doesn’t even take into account almost certainly receiving additional revenue from those clients, plus referrals etc.  CAC would probably have to be much higher than LTV ( in the first year ) to cause a long term structural problem with the business model. 

        • You can choose to do that all day long but of course it means you have to finance that gap. That is the problem. It’s why the advisory business has limits to growth. If you don’t mind those limits you’re all set.

          • Guest2

            LTV to be at least 3x CAC? You only plan on keeping a client for 3 years? This assumes you breakeven in the first year? I think this is where many advisors miss it. If I bring on a client that pays me $10k per year, why wouldn’t I spend $10k, $15k, or $20k to get them? Most advisors rely on cheap methods or shotgun approaches to getting new clients…neither work. You have to have a laser focus and spend larger amounts of money getting that one prospects attention.

          • Keep a client for only 3 years, of course not. It’s not the point. This is meant to be a minimum guideline. Blueleaf’s customer LTV is 41.9x CAC as an example. 

            However, as a financial matter you might like to do that all day long but unless you’ve got an unlimited source of working capital, you can’t. 

            Using your numbers, let’s say I spend $15K for a client that is worth $10K. Let’s further assume you acquire everyone on average in the middle of the year. Obviously this is a gross simplification but the logic holds. That would mean that you’re financing $10K for every new client in acquisition costs. If you bring on just 10 new clients that $100K in working capital. 

            If you can finance it, go for it. Most advisory firms have limited access to working capital which means a relationship like this puts a hard limit on their growth rate.

  • Skiphick77

    Quoting that 4/5th of advisors don’t make it 5years, and then linking to an 11 year old article which is about brokers seems odd to me.

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  • Add me to the list of those willing to have a flat or negative one-year LTV-CAC. Of course, one would want as high of a LTV/CAC ratio as possible. However, the value of client revenue is well documented via M&A multiples, and are nearly always greater than 1X (usually significantly higher in the 2.5-3X range) and thus, have negative (one year) LTV-CAC.

    *really hard to grasp the usage of “one-year LTV” as a viable concept.

    • Michael, I’ll add you to the list. However, I’ve got a question which I think is important.

      Are you saying that in the abstract you’d take the trade off or that you have the capacity to finance it in enough volume to hit your target growth rate?

      As far as M&A, I’m a former investment banker and I certainly take your point about the equity value created by each new client.

      However, growth also adds to multiples and if I can add another turn to the multiple for the whole business because I can finance a higher growth rate, I’d prefer that.

      As far as the “one-year” rule of thumb. It’s a heuristic to make sure we’re clearly thinking about the working capital implications of the relationship between CAC & LTV. One year will typically create a financeable situation.

  • Patrick

    What if the $21,600 doesn’t result in a client until the following year or further out. Somebody attends your event, likes what they see and then calls you 3 years later when some trigger occurs. How do you account for that?

    • Patrick,

      This is a great question.

      The truth is that attributing costs directly to individual new customers isn’t typically possible. However, we are mostly interested in the average across all new clients. CAC is a calculated for a specific period so there are 2 ways to think about it:

      1) If your efforts tend to vary alot year to year, calculate CAC for a 3 or 4 year period. That way your average would directly capture it and include the changes in marketing effort, or

      2) If you’re fairly consistent in your efforts calculate CAC over shorter periods like annually or quarterly and assume that it works itself out in the average.

      Hope that helps.

  • Steve Drozdeck

    Excellent article. A topic that advisors should be fully aware of.

  • Bryan

    I hope my competition views it this way. If it costs me $1.50 or $2.00 to acquire $1.00 in revenue the first year, I’m thrilled to pay that. Because I know that I’m likely to have that client for 10+ years, and I already know the cost to maintain that client is about $0.25 – $0.30 per year for every $1.00 of revenue. So I can outspend my competition for marketing and advertising if they’re short sided in their thinking to build the long term success of my practice.

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