What is the Rule of 40?
The Rule of 40 is a SaaS health benchmark: a company’s annual revenue growth rate (%) plus its profitability margin (%) should equal or exceed 40%. Coined by Brad Feld (2015) and popularized by VC investors, it provides a quick read on whether a SaaS company is “balanced” — trading growth for profitability or vice versa in a healthy way.
Formula
Rule of 40 = YoY Revenue Growth % + Profitability Margin %
Where Profitability Margin can be: EBITDA margin, Free Cash Flow margin, Operating margin, or Adjusted EBITDA margin. The variant matters — be explicit when comparing across companies.
Examples
- 40% growth + 0% margin = 40 ✓
- 20% growth + 20% margin = 40 ✓
- 60% growth + -25% margin = 35 ✗
- 10% growth + 35% margin = 45 ✓ (mature/efficient)
Investor use
Public SaaS investors use Rule of 40 to rank potential investments; Bessemer, ICONIQ, OpenView publish quarterly ranked lists. Private-market investors apply the same logic. Below-40 companies face multiple compression. Above-50 companies command premium multiples (current 2025 EV/Revenue median: ~6x for 40-50; ~10x+ for 50+).
Limits
- Doesn’t work for early-stage (<$10M ARR) — most are negative on both axes
- Doesn’t capture quality of growth (high vs low NRR, organic vs acquired)
- EBITDA can be gamed via capitalized R&D, deferred bonuses, related-party rent
Practical implications
For Series B+ rounds, expect Rule of 40 as a standard slide. Get there by improving either side: efficient growth (CAC payback, sales efficiency) OR margin expansion (R&D capitalization, hosting cost optimization, pricing increases). See our VC DD Checklist for related metrics.
References
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