The Rule of 40
The Rule of 40 is a benchmark for SaaS company health:
A score of 40 or above is considered healthy.
Why It Matters
The Rule of 40 captures the fundamental SaaS trade-off: growth and profitability. Early-stage companies prioritize growth over margins; mature companies prioritize margins over growth. The Rule of 40 says both are acceptable as long as the sum is 40+.
Examples: - 60% growth, −20% margin = Score: 40 ✓ - 20% growth, 25% margin = Score: 45 ✓ - 15% growth, 5% margin = Score: 20 ✗
Which Profit Margin?
Different practitioners use different profit metrics: - EBITDA margin: Most common for pre-IPO companies - Free cash flow margin: Preferred by public market investors - Net income margin: Most conservative
Limitations
Rule of 40 works best for companies with $10M+ ARR. For very early-stage startups, growth rate alone matters more. For large public companies, free cash flow margin is often the better profitability input.
Use the Revenue Growth Rate Calculator to compute your Rule of 40 score.