Rule of 40 is a SaaS heuristic: year-over-year revenue growth % + profit margin % ≥ 40%.

How it works

If ARR grows 35% YoY and EBITDA margin is 8%, Rule of 40 score = 43 — passing the threshold. A company growing 60% at −25% margin scores 35 — failing, but possibly acceptable at early scale where efficiency rules are relaxed.

Margin definition varies: EBITDA, operating margin, or free cash flow margin. Public SaaS investors popularized the metric; private boards adopt it for Series C+ when growth slows and profitability questions rise.

Rule of 40 is not physics — high-growth startups intentionally fail it while investing in GTM. It bites when growth decelerates and losses remain large.

Pair with burn multiple, net revenue retention, and SaaS metrics for fuller picture.

Why it matters

• Founders: Use it to justify investment phase vs profit push in board conversations — name which margin you use consistently.
• Investors: Quick screen for public comps and late-stage private pricing; sub-40 names face multiple compression in risk-off markets.

Common mistake

Applying Rule of 40 to pre-product companies with meaningless margin lines. It is most informative once revenue base is material and growth rates are sustainable percentages, not triple-digit from tiny bases.

Related ideas

See also SaaS metrics, burn multiple, revenue churn, and CAC payback.