Rule of 40
A benchmark stating that a SaaS company's combined revenue growth rate and profit margin should equal or exceed 40%. Companies above 40 are considered well-balanced between growth and profitability.
What the Rule of 40 Actually Tells You
The Rule of 40 exists because SaaS investors got tired of arguing about growth versus profitability. It acknowledges the tradeoff — you can grow fast with thin margins, or grow slowly with fat margins, and both can be healthy. The number just has to add up to 40 or more.
The Calculation
Rule of 40 = YoY Revenue Growth Rate (%) + Profit Margin (%)
Use EBITDA margin or free cash flow margin. Some companies use operating margin. Pick one and be consistent. The growth rate should be year-over-year ARR growth, not quarter-over-quarter annualized.
Where It Falls Short
Rule of 40 treats a 5% growth / 35% margin company the same as a 35% growth / 5% margin company. They both score 40. But they are very different businesses with very different futures. High-growth companies can optimize margins later. Low-growth companies with high margins are often ex-growth stories. Context always matters more than the formula.
Who Should Care About Rule of 40
If you are pre-Series B, do not worry about Rule of 40. Focus on product-market fit, CAC payback, and burn multiple. Once you are past $10M ARR and starting to think about efficiency, Rule of 40 becomes relevant. By the time you are north of $50M ARR, it is one of the primary metrics your board tracks.
Frequently Asked Questions
How do you calculate Rule of 40?
Revenue growth rate (YoY %) plus EBITDA margin (or free cash flow margin). If you are growing at 60% with -15% margins, your score is 45 — you pass. If you are growing at 20% with 15% margins, your score is 35 — you are below the benchmark. Growth or profitability can carry the number.
Is Rule of 40 still relevant?
Yes, but it is better suited for growth-stage and later companies. Pre-Series B startups should focus more on burn multiple and CAC payback. For public SaaS companies and late-stage privates, Rule of 40 remains the standard benchmark that investors, analysts, and boards use.
