Imperfect Projections

Christian Garrett
3 min readMay 2, 2020

Within the two dominant fields in private investing, venture capital and private equity, each seem to have their financial formula north star. What the DCF is to PE, the LTV:CAC ratio is to VC (excuse the crude generalization and just go with it). Both are critical calculations in understanding the present value of a company. Yet, both have 2 flaws, which stem from the assumptions given to their mathematical variable inputs. Below are some brief thoughts on these inputs.

To begin, the LTV:CAC ratio is a great tool for understanding one’s growth engine and the unit economics of certain business models. Is your output (revenue generated from acquired customers) greater than your input (the cost of acquiring said customers)? The problem here, is that while CAC is possible to mathematically measure, LTV tends to be a projected assumption from a limited present data set. A startup with just 2 years of cohort data cannot properly project the lifecycle of customers. Whatever number chosen may be accurate, and is not purposefully false, but it needs to be weighted for it’s speculative nature. How do you presently project into LTV the possibility of future competition drastically altering your CAC:LTV ratio through stealing customers, or increasing digital marketing spend? Current retention data is not a entirely sufficient proxy. Once again, no formula is perfect. (This is why payback models are so critical, because businesses with fast payback periods can generate positive customers within Year 1, after subtracting the cost of acquiring those customers, leaving all future theoretical profits as an option of sorts in subsequent years.)

Next, we will look at the DCF, the bane of every investment banker’s existence. To be clear, the DCF (like LTV:CAC) is a great tool. The point I have been thinking on is more a thought into how weighted are some of these imperfect assumptions that are key inputs in the formula. It is nearly impossible to predict with any accuracy what the long-term cash flows are for a given company; especially a company that is young or that might be using an innovative and new business model. On top of that, knowing what long-term cash flows will look like requires knowledge of a vast number of imperfect future variables — long-term growth rate, long-term operating margin, reinvestment, and pressure from competition. I am not sure if there is a possible way to properly discount and account for these variable factors (I am sure Aswath Damodaran has some fun discussions on this), but I think being aware that your projections are just projections is key when building or when valuing a business.

In conclusion, these formulas are very valuable and will continue to be relied upon by operators and investors alike. Thinking about some of the imperfections in some of the variable assumptions helps one to more accurately understand the business, and more accurately strategize building a strong one.

— Opinions expressed are solely my own and do not express the views or opinions of my employer, 137 Ventures

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Christian Garrett

137 Ventures. Kansas Jayhawk. Revivalist. Futurist. I enjoy writing about all the diverse (and random) subjects that interest me. All opinions are my own.