The Rule of 40 serves as a critical benchmark for SaaS companies seeking to balance growth and profitability.

This metric provides a straightforward way to measure financial health, offering a clear signal to investors, board members, and management teams about business sustainability.

At VH Info, our work with numerous SaaS companies has shown that understanding and tracking this metric is essential for companies aiming to grow effectively while maintaining healthy financials.

What Is The Rule Of 40?

The Rule of 40 states that a healthy SaaS company’s combined revenue growth rate and profit margin should equal or exceed 40%, reflecting its growth potential. This formula creates a single metric that balances two competing priorities: growing quickly and operating profitably.

For example, if your SaaS business has a 30% annual recurring revenue growth rate and a 15% profit margin, your Rule of 40 score would be 45%, indicating your company achieves a favorable balance of growth and profitability, meeting the benchmark for financial health. Conversely, if you have 50% growth but a -15% profit margin, your score would be 35%, falling short of the standard.

The Rule of 40 was popularized by venture capitalist Brad Feld in 2015, though it was already being used by investors before then. It recognizes the inherent trade-off SaaS companies face: investing in growth often means sacrificing near-term profitability.

Who Uses The Rule Of 40?

The Rule of 40 is primarily used by:

• Venture capital firms evaluating potential investments
• SaaS company executives monitoring their financial performance
• Board members assessing management team effectiveness
• Financial analysts comparing companies within the SaaS industry
• Potential acquirers evaluating acquisition targets

While originally intended for SaaS companies with over $50 million in annual revenue, the Rule of 40 is now applied to businesses at various stages, though it’s most relevant for companies with established revenue streams.

How The Rule Of 40 Works?

The Rule of 40 works by acknowledging a fundamental reality: fast-growing companies typically invest heavily in sales, marketing, and product development to acquire new customers, often operating at a loss.

Meanwhile, highly profitable SaaS companies might have lower growth rates because they’re investing less in expansion.

This creates flexibility in how SaaS companies can meet the benchmark:

• A high-growth startup might have 60% growth with -20% profit margin (Rule of 40 score: 40%)
• A mature SaaS company might have 15% growth with a 25% profitability margin (Rule of 40 score: 40%)
• A high-performing company might have 50% growth with a 10% profit margin (Rule of 40 score: 60%)

Each of these companies would meet or exceed the Rule of 40 through different combinations of growth and profitability.

Why Use The Rule Of 40? Here Are Four Important Benefits

The Rule of 40 offers several significant advantages for SaaS companies:

1. Simplified Performance Assessment: The Rule of 40, often considered a rule of thumb, combines two critical metrics into a single number, making it easier to gauge a company’s financial health. Management teams can use this as a starting point for deeper analysis.
2. Balanced Growth Approach: Many SaaS companies fall into the “growth at all costs” trap, burning through cash without a path to profitability. The Rule of 40 encourages a more balanced approach by recognizing that extreme growth at the expense of profitability isn’t sustainable.
3. Investor Attraction: SaaS companies that meet or exceed the Rule of 40 typically command higher revenue multiples from investors. Venture capital firms often use this metric as a screening tool when evaluating potential investments.
4. Strategic Decision Framework: The Rule of 40 helps inform resource allocation decisions. If your score is well above 40%, you might have room to invest more aggressively in growth. If you’re below 40%, you might need to focus on improving efficiency or profitability.

When To Use The Rule Of 40: Should You Measure The Rule Of 40 As A Startup?

While valuable, the Rule of 40 isn’t equally applicable to all SaaS companies at every stage:

1. Early-Stage Startups (Pre-Revenue Or <$1M ARR): The Rule of 40 is less relevant. Focus instead on product-market fit and establishing initial revenue streams.
2. Growth-Stage Companies ($1M-$10M ARR): Begin monitoring the Rule of 40, but recognize that heavy investment in growth might mean your score is below 40%. Investors will understand this if your growth metrics are strong.
3. Scale-Up companies ($10M+ ARR): The Rule of 40 becomes increasingly important. At this stage, investors expect to see a clearer path to balancing growth and profitability.
4. Mature SaaS companies ($50M+ ARR): The Rule of 40 is a critical benchmark. Companies at this scale are expected to demonstrate sustainable economics while maintaining reasonable growth.

Brad Feld initially suggested the Rule of 40 was most applicable to companies with over $50 million in annual revenue, but many investors now apply it to companies with as little as $1-5 million in ARR, adjusting their expectations based on company’s stage.

The Rule Of 40 Formula

The basic Rule of 40 formula is straightforward:

Rule of 40 = Revenue Growth Rate (%) + Profit Margin (%)

While this looks simple, there are important considerations about which specific metrics to use:

1. Revenue Growth Rate: Most commonly measured as year-over-year growth in total revenue, annual recurring revenue (ARR) or monthly recurring revenue (MRR)
2. Profit Margin: Can be measured using several metrics, including:

• EBITDA margin (most common)
• Free cash flow margin
• Operating margin
• Net income margin

The specific profit metric you choose can significantly impact your Rule of 40 calculation. EBITDA margin is most commonly used because it excludes non-operational factors like interest expense and focuses on core business performance.

How To Calculate The SaaS Rule Of 40 (Example)

Let’s examine practical examples of calculating the Rule of 40 for two hypothetical SaaS companies.

Example 1: A Company Meeting The Rule Of 40

SaaSCo has the following metrics:

• Current ARR: $25 million
• Previous year ARR: $17.5 million
• EBITDA: $0.75 million

Step 1: Calculate The Revenue Growth Rate:

($25M – $17.5M) / $17.5M = 0.429 or 42.9%

Step 2: Calculate The Profit Margin:

$0.75M / $25M = 0.03 or 3%

Step 3: Apply The Rule Of 40 Formula:

42.9% + 3% = 45.9%

With a Rule of 40 score of 45.9%, SaaSCo exceeds the 40% benchmark, indicating a healthy balance between growth and profitability. The company is growing rapidly while maintaining slight profitability.

Example 2: A Company Not Meeting The Rule Of 40

CloudApp has the following metrics:

• Current ARR: $15 million
• Previous year ARR: $12 million
• EBITDA: -$2.25 million

Step 1: Calculate The Revenue Growth Rate:

($15M – $12M) / $12M = 0.25 or 25%

Step 2: Calculate The Profit Margin:

-$2.25M / $15M = -0.15 or -15%

Step 3: Apply The Rule Of 40 Formula:

25% + (-15%) = 10%

With a Rule of 40 score of just 10%, CloudApp falls significantly short of the 40% benchmark. This suggests the company may need to either accelerate growth or improve profitability to reach a healthier balance.

How To Calculate The SaaS Rule Of 40?

Let’s break down the calculation into its parts.

Revenue Growth Rate Calculation

For SaaS companies, the revenue growth rate typically focuses on recurring revenue metrics:

Revenue Growth Rate = (Current Period Revenue – Prior Period Revenue) / Prior Period Revenue

The preferred revenue metric is typically:

• Annual Recurring Revenue (ARR) for companies with mostly annual contracts
• Monthly Recurring Revenue (MRR) for companies with monthly subscription models

MRR is calculated as:

Monthly Recurring Revenue (MRR) = Total Number of Active Accounts × Average Revenue Per Account

To convert MRR to ARR, simply multiply by twelve:

Annual Recurring Revenue (ARR) = Monthly Recurring Revenue (MRR) × 12 Months

Profit Margin Calculation

The profit margin measures how much of your revenue translates to profit. EBITDA margin is most commonly used for the Rule of 40:

EBITDA Margin = EBITDA / Revenue

Where EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.

Some companies use free cash flow margin instead:

Free Cash Flow Margin = Free Cash Flow / Revenue

The choice of profit metric can significantly impact your Rule of 40 score, so it’s important to be consistent and transparent about which metric you’re using.

Add The Growth Rate and Profit Margin

Once you have calculated both components, simply add them together:

Rule of 40 = Revenue Growth Rate (%) + Profit Margin (%)

If the result is 40% or higher, the company meets the Rule of 40 benchmark.

How Many SaaS Companies Exceed The Rule Of 40?

Based on market data, only a minority of SaaS companies achieve the Rule of 40 benchmark.

According to our research, approximately 20-30% of public SaaS companies meet or exceed the Rule of 40, with the percentage varying based on market conditions.

Looking at the list from our search results, we can see numerous companies that meet the Rule of 40, including Adobe, Microsoft, Oracle, and other established software companies. The list also includes smaller, high-growth companies with scores well above 40%.

Meeting the Rule of 40 becomes more common as companies mature and achieve scale.

SaaS companies that consistently exceed the Rule of 40 are typically either:

1. High-growth companies with strong unit economics
2. More mature SaaS businesses that have found an optimal balance
3. Category leaders with strong network effects or high barriers to entry

The companies on the Rule of 40 list demonstrate a wide range of scores, from just above 40% to some with remarkably high scores of 100%+ (often high-growth companies with modest losses).

Is The Rule Of 40 Still Relevant?

1. The First Test Of The Rule Of 40: The Rule of 40 gained popularity during a period of economic stability and strong SaaS growth from 2015-2020. It faced its first significant test during the economic disruption of 2020-2021, when many SaaS companies saw fluctuating growth rates and changing profit margins.
2. Growth Slowdown: In recent years, we’ve seen a growth slowdown across the SaaS industry as markets have matured and competition has intensified. This has made it harder for companies to achieve the high growth rates seen in previous years, putting pressure on the growth component of the Rule of 40.
3. Inflation and The Rule Of 40: In recent years, we’ve seen a growth slowdown across the SaaS industry as markets have matured and competition has intensified. This has made it harder for companies to achieve the high growth rates seen in previous years, putting pressure on the growth component of the Rule of 40.
4. Focus On Profitability: Since 2022-2023, there’s been a notable shift in investor sentiment toward profitability and sustainable economics. The “growth at all costs” mentality has been replaced by a greater emphasis on unit economics and path to profitability. This has made the Rule of 40 even more relevant, but with greater emphasis on the profit component.
5. The Future Of The Rule Of 40: The Rule of 40 is still relevant in 2025, but investors now focus on its consistency over time, trends in revenue growth and profitability, and other efficiency metrics. While specific benchmarks may shift with market conditions, the core idea of balancing growth rate and profit margin remains a trusted measure of financial health for SaaS companies.

Rule Of X – An Alternative To Rule Of 40?

Some investors and analysts have proposed variations on the Rule of 40, sometimes called the “Rule of X,” where X varies based on company stage, industry segment, or market conditions.

Common variations include:

• Rule of 30: For earlier-stage companies or during challenging economic periods
• Rule of 50: For high-performing SaaS companies or during strong market conditions
• Rule of 60: For top-tier SaaS businesses with exceptional economics

The appropriate benchmark may vary based on:

• Company size and maturity
• Growth rate of the specific SaaS segment
• Overall market conditions
• Competitive landscape
• Capital availability

At VH Info, we recommend SaaS companies benchmark against peers in their specific segment and stage rather than applying a one-size-fits-all approach to the Rule of 40.

FAQ’s:

What Constitutes A Good Rule Of 40 Score?

A Rule of 40 score above 40% is generally considered good, indicating a healthy balance between growth and profitability.

Scores of 50% or higher are excellent, suggesting a company that’s either growing very quickly with acceptable losses or growing steadily with strong profitability.

Early-stage companies may temporarily fall below 40% while investing heavily in growth, but should aim to reach this benchmark as they mature.

How Often Should SaaS Companies Calculate The Rule Of 40?

Most SaaS companies calculate the Rule of 40 quarterly, aligning with their financial reporting cycles.

However, tracking it monthly can provide earlier signals of changes in performance. When reporting to investors or board members, quarterly or annual Rule of 40 calculations are most common. What’s most important is consistency in how and when you measure it.

Can The Rule Of 40 Be Applied To Non-SaaS Companies?

While the Rule of 40 was developed specifically for SaaS businesses, the underlying principle of balancing growth and profitability applies to other subscription-based or recurring revenue business models.

Some adaptations have been made for managed service providers, e-commerce subscription businesses, and certain fintech models with recurring revenue.

The specific 40% threshold may need adjustment for different business models with different margin structures or growth expectations.

How Does Investor Perception Change With Rule Of 40 Scores?

Investor perception generally improves as Rule of 40 scores increase:

• Below 20%: Often indicates fundamental business model issues
• 20-30%: Below average, may face valuation discounts
• 30-40%: Approaching healthy territory but room for improvement
• 40-50%: Healthy, attractive to most investors
• 50%+: Premium valuations likely, highly attractive to investors

Higher Rule of 40 scores typically correlate with higher revenue multiples, though the relationship isn’t perfectly linear and varies with market conditions.

Where Did The Rule Of 40 Come? Can You Be Too Far Over The Rule Of 40?

The Rule of 40 was popularized by venture capitalist Brad Feld in a 2015 blog post, though he attributes the concept to a late-stage investor he encountered during a board meeting. The rule quickly gained traction in the venture capital community and among SaaS executives.

As for being “too far” over 40%, it’s generally not a problem to exceed the benchmark significantly. However, an extremely high score (e.g., 80%+) might indicate unsustainable growth that will inevitably slow down or under-investment in areas that could drive future growth.

How Many Companies Outperform The Rule Of 40?

Based on market data, approximately 20-30% of public SaaS companies exceed the Rule of 40 benchmark at any given time. The percentage varies with market conditions and can change substantially during economic shifts.

Among the companies meeting the Rule of 40, there’s significant variation in how they achieve it – some through high growth with minimal profitability, others through moderate growth with strong margins.

Conclusion

The Rule of 40 remains a valuable benchmark for SaaS companies seeking to balance growth and profitability.

By offering a unified metric that integrates two key components of financial performance, it enables executives, board members, and investors to swiftly evaluate a company’s health and sustainability.

While not every SaaS company needs to meet the Rule of 40 at every stage of development, it provides a north star to guide strategic decision-making as businesses mature. Companies that consistently meet or exceed this benchmark typically enjoy stronger valuations, greater investor interest, and more strategic options.

At VH Info, we work with SaaS companies to improve their link building strategies and digital presence. We’ve seen how strong financial fundamentals support every aspect of a SaaS business, from marketing effectiveness to customer acquisition efficiency.

Whether you’re just starting to track the Rule of 40 or looking to improve your current score, focus on the underlying drivers of sustainable growth and improving unit economics.

Remember that the Rule of 40 is a means to measure business health, not an end in itself – the goal is building a sustainable, valuable SaaS business that creates long-term value for customers, employees, and shareholders.