Rule of 40
A benchmark that says a healthy SaaS company should have its revenue growth rate plus profit margin equal or exceed 40%. It balances growth against profitability.
What Is the Rule of 40?
The Rule of 40 is a benchmark that says a healthy SaaS company's combined revenue growth rate and profit margin should equal or exceed 40%. For example, a company growing at 30% year-over-year with a 10% EBITDA margin scores exactly 40. The metric was popularized by venture investors as a quick heuristic for evaluating whether a SaaS business is balancing growth and efficiency appropriately.
How to Calculate the Rule of 40
Rule of 40 = Revenue Growth Rate (%) + Profit Margin (%)
Revenue growth is typically measured year-over-year using ARR or total revenue. Profit margin is usually EBITDA margin, though some use free cash flow margin. The key is consistency — pick one method and stick with it for tracking over time.
What Is a Good Rule of 40 Score?
Scores above 40% are considered healthy. Top-tier SaaS companies like those in the BVP Cloud Index often score 50-60%+. Early-stage companies may sacrifice profitability for growth (e.g., 80% growth + -40% margins = 40), while mature companies flip the ratio (e.g., 15% growth + 30% margins = 45). The key insight is that neither extreme growth nor extreme profitability alone makes a great SaaS business — the balance matters.
Rule of 40 and SaaS Valuation
Companies that exceed the Rule of 40 consistently trade at higher valuation multiples. Investors view the Rule of 40 as a proxy for capital efficiency — it shows whether a company can grow without burning through cash unsustainably. If you are preparing for a fundraise or exploring revenue-based financing, your Rule of 40 score is one of the first things a lender or investor will check.
