Rule of 40 (%)
Industry:
SaaS
Growth
Profitability
Aliases:
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Short Definition
The Rule of 40 (%) is a key metric for SaaS companies, combining revenue growth rate and profit margin (like Free Cash Flow or EBITDA margin). A score of 40% or higher indicates a healthy balance between growth and profitability. This benchmark helps evaluate capital efficiency and guides strategic decisions.
Short Definition
The Rule of 40 (%) is a key metric for SaaS companies, combining revenue growth rate and profit margin (like Free Cash Flow or EBITDA margin). A score of 40% or higher indicates a healthy balance between growth and profitability. This benchmark helps evaluate capital efficiency and guides strategic decisions.
Short Definition
The Rule of 40 (%) is a key metric for SaaS companies, combining revenue growth rate and profit margin (like Free Cash Flow or EBITDA margin). A score of 40% or higher indicates a healthy balance between growth and profitability. This benchmark helps evaluate capital efficiency and guides strategic decisions.
Why it matters for Investors
One number, two engines: Captures the trade-off between growth and profitability.
Capital efficiency lens: Rewards growth that converts to cash, penalizes “bought” growth.
Comparable across stages: Works as a directional benchmark from scale-up to public.
Why it matters for Investors
One number, two engines: Captures the trade-off between growth and profitability.
Capital efficiency lens: Rewards growth that converts to cash, penalizes “bought” growth.
Comparable across stages: Works as a directional benchmark from scale-up to public.
Why it matters for Investors
One number, two engines: Captures the trade-off between growth and profitability.
Capital efficiency lens: Rewards growth that converts to cash, penalizes “bought” growth.
Comparable across stages: Works as a directional benchmark from scale-up to public.
Formula
Practical considerations -
Lock your policy: Specify which growth (Revenue vs ARR) and which margin (FCF vs EBITDA vs Operating).
Use TTM/rolling periods: Smooth seasonality and billing cyclicality.
Same currency & basis: If using constant-currency growth or “Adjusted” margins, label and reconcile.
Negative is allowed: A profitable slow grower or a fast grower with losses can still hit ≥40%.
Segment views: New-logo vs expansion growth, or by product/region, to see what drives the score.
Formula
Practical considerations -
Lock your policy: Specify which growth (Revenue vs ARR) and which margin (FCF vs EBITDA vs Operating).
Use TTM/rolling periods: Smooth seasonality and billing cyclicality.
Same currency & basis: If using constant-currency growth or “Adjusted” margins, label and reconcile.
Negative is allowed: A profitable slow grower or a fast grower with losses can still hit ≥40%.
Segment views: New-logo vs expansion growth, or by product/region, to see what drives the score.
Formula
Practical considerations -
Lock your policy: Specify which growth (Revenue vs ARR) and which margin (FCF vs EBITDA vs Operating).
Use TTM/rolling periods: Smooth seasonality and billing cyclicality.
Same currency & basis: If using constant-currency growth or “Adjusted” margins, label and reconcile.
Negative is allowed: A profitable slow grower or a fast grower with losses can still hit ≥40%.
Segment views: New-logo vs expansion growth, or by product/region, to see what drives the score.
Worked Example
Line Item | Value | Notes |
|---|---|---|
YoY Revenue Growth (TTM) | 28% | \frac{\text{Revenue}_{TTM}-\text{Revenue}_{TTM-1}}{\text{Revenue}_{TTM-1}} |
Profitability Margin (TTM, FCF Margin) | 18% | \frac{\text{FCF}_{TTM}}{\text{Revenue}_{TTM}} |
Rule of 40 (%) | 46% | 28 + 18 → passes the 40% bar |
Notes
Consistency: Both components are TTM and in the same currency.
Label choices: Because margin = FCF Margin, disclose if any “Adjusted FCF” items are used.
If using ARR growth: Name it clearly, e.g., “Rule of 40 (ARR + FCF)”.
Interpretation (directional): <30% weak · 30–40% borderline · 40–60% healthy · >60% elite (stage/sector dependent).
Worked Example
Line Item | Value | Notes |
|---|---|---|
YoY Revenue Growth (TTM) | 28% | \frac{\text{Revenue}_{TTM}-\text{Revenue}_{TTM-1}}{\text{Revenue}_{TTM-1}} |
Profitability Margin (TTM, FCF Margin) | 18% | \frac{\text{FCF}_{TTM}}{\text{Revenue}_{TTM}} |
Rule of 40 (%) | 46% | 28 + 18 → passes the 40% bar |
Notes
Consistency: Both components are TTM and in the same currency.
Label choices: Because margin = FCF Margin, disclose if any “Adjusted FCF” items are used.
If using ARR growth: Name it clearly, e.g., “Rule of 40 (ARR + FCF)”.
Interpretation (directional): <30% weak · 30–40% borderline · 40–60% healthy · >60% elite (stage/sector dependent).
Worked Example
Line Item | Value | Notes |
|---|---|---|
YoY Revenue Growth (TTM) | 28% | \frac{\text{Revenue}_{TTM}-\text{Revenue}_{TTM-1}}{\text{Revenue}_{TTM-1}} |
Profitability Margin (TTM, FCF Margin) | 18% | \frac{\text{FCF}_{TTM}}{\text{Revenue}_{TTM}} |
Rule of 40 (%) | 46% | 28 + 18 → passes the 40% bar |
Notes
Consistency: Both components are TTM and in the same currency.
Label choices: Because margin = FCF Margin, disclose if any “Adjusted FCF” items are used.
If using ARR growth: Name it clearly, e.g., “Rule of 40 (ARR + FCF)”.
Interpretation (directional): <30% weak · 30–40% borderline · 40–60% healthy · >60% elite (stage/sector dependent).
Best Practices
Publish the recipe: Growth definition, margin definition, period basis, and any adjustments.
Show the parts: Report both growth and margin next to the Rule of 40 score.
Trend it: Present quarterly and TTM time series; call out one-offs.
Bridge drivers: Price/mix/volume for growth; gross margin & OpEx for profitability.
Segment: New vs existing customers, products, or regions to see where efficiency comes from.
Best Practices
Publish the recipe: Growth definition, margin definition, period basis, and any adjustments.
Show the parts: Report both growth and margin next to the Rule of 40 score.
Trend it: Present quarterly and TTM time series; call out one-offs.
Bridge drivers: Price/mix/volume for growth; gross margin & OpEx for profitability.
Segment: New vs existing customers, products, or regions to see where efficiency comes from.
Best Practices
Publish the recipe: Growth definition, margin definition, period basis, and any adjustments.
Show the parts: Report both growth and margin next to the Rule of 40 score.
Trend it: Present quarterly and TTM time series; call out one-offs.
Bridge drivers: Price/mix/volume for growth; gross margin & OpEx for profitability.
Segment: New vs existing customers, products, or regions to see where efficiency comes from.
FAQs
Which margin should I use?
Use FCF Margin if cash efficiency is the goal; EBITDA/Operating Margin if comparability to peers requires it. Pick one and stick with it.Can I mix ARR growth with Revenue growth?
Avoid mixing. If you choose ARR growth, label it explicitly and use the same basis next periods.What if one component is negative?
That’s fine—the sum still tells the story (e.g., 60% growth and −10% margin ⇒ 50%).Is 40% a hard rule?
No—it’s a heuristic. Expectations vary by stage, cycle, and sector.
FAQs
Which margin should I use?
Use FCF Margin if cash efficiency is the goal; EBITDA/Operating Margin if comparability to peers requires it. Pick one and stick with it.Can I mix ARR growth with Revenue growth?
Avoid mixing. If you choose ARR growth, label it explicitly and use the same basis next periods.What if one component is negative?
That’s fine—the sum still tells the story (e.g., 60% growth and −10% margin ⇒ 50%).Is 40% a hard rule?
No—it’s a heuristic. Expectations vary by stage, cycle, and sector.
FAQs
Which margin should I use?
Use FCF Margin if cash efficiency is the goal; EBITDA/Operating Margin if comparability to peers requires it. Pick one and stick with it.Can I mix ARR growth with Revenue growth?
Avoid mixing. If you choose ARR growth, label it explicitly and use the same basis next periods.What if one component is negative?
That’s fine—the sum still tells the story (e.g., 60% growth and −10% margin ⇒ 50%).Is 40% a hard rule?
No—it’s a heuristic. Expectations vary by stage, cycle, and sector.
Related Metrics
Gross Margin (%), EBITDA Margin (%), Free Cash Flow (and FCF Margin %), CAC Payback (Months), Burn Multiple, Net Dollar Retention (NRR), Magic Number
Commonly mistaken for:
Gross Margin: Unit-level economics, not growth + profitability.
Rule of 40 using mixed bases: (e.g., ARR growth with EBITDA margin on revenue) — don’t mix bases.
CAC Payback / Burn Multiple: Efficiency metrics, but not a sum of growth and profitability.
Related Metrics
Gross Margin (%), EBITDA Margin (%), Free Cash Flow (and FCF Margin %), CAC Payback (Months), Burn Multiple, Net Dollar Retention (NRR), Magic Number
Commonly mistaken for:
Gross Margin: Unit-level economics, not growth + profitability.
Rule of 40 using mixed bases: (e.g., ARR growth with EBITDA margin on revenue) — don’t mix bases.
CAC Payback / Burn Multiple: Efficiency metrics, but not a sum of growth and profitability.
Related Metrics
Gross Margin (%), EBITDA Margin (%), Free Cash Flow (and FCF Margin %), CAC Payback (Months), Burn Multiple, Net Dollar Retention (NRR), Magic Number
Commonly mistaken for:
Gross Margin: Unit-level economics, not growth + profitability.
Rule of 40 using mixed bases: (e.g., ARR growth with EBITDA margin on revenue) — don’t mix bases.
CAC Payback / Burn Multiple: Efficiency metrics, but not a sum of growth and profitability.
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