The Rule of 40 for SaaS
Revenue growth rate plus profit margin should equal 40% or more. Here's how the Rule of 40 works, what it tells investors, and where it falls short.
What is the Rule of 40?
The Rule of 40 is a benchmark for evaluating SaaS businesses. The idea is simple: your revenue growth rate plus your profit margin should add up to at least 40%.
It was popularised by venture capitalist Brad Feld and has become one of the standard metrics investors use when sizing up SaaS companies. The appeal is that it captures the trade-off between growth and profitability in a single number.
A company growing at 60% with a -15% margin scores 45%. A company growing at 10% with 35% margins also scores 45%. The Rule of 40 treats both as equally healthy, which is both the metric’s strength and its limitation.
The formula
Rule of 40 score = Revenue growth rate (%) + Profit margin (%)
That’s it. Two numbers, one addition.
Revenue growth rate is typically measured year-over-year. Profit margin is usually EBITDA margin or operating margin, though there’s no universal standard. Some companies use free cash flow margin instead. The important thing is consistency: pick one definition and stick with it.
Worked example
Say your SaaS business did $1.2M in ARR last year and $1.8M this year. Your monthly operating expenses average $120K against $150K in monthly revenue.
Revenue growth rate = ($1.8M - $1.2M) / $1.2M × 100 = 50%
Profit margin = ($150K - $120K) / $150K × 100 = 20%
Rule of 40 score = 50% + 20% = 70%
That’s well above the threshold. This business is growing quickly and profitable. In practice, most companies at this level are either bootstrapped and efficient, or have found genuine product-market fit.
What is a good score?
| Score | Interpretation |
|---|---|
| 60%+ | Best-in-class. Commands premium valuations (10x+ ARR multiples). |
| 40-60% | Healthy. Growth and profitability are well balanced. |
| 25-40% | Below the line but not alarming. Common for companies investing heavily in growth. |
| Below 25% | Needs attention. Either growth has stalled or the business is burning cash without adequate return. |
A few things the benchmarks don’t capture. A company scoring 45% with 40% growth and 5% margins is in a fundamentally different position from one scoring 45% with 5% growth and 40% margins. The first has momentum. The second is a lifestyle business (nothing wrong with that, but the trajectory is different).
Bessemer Venture Partners tracks Rule of 40 scores across their cloud index. The top quartile consistently scores above 50%. The median sits around 30-35%, meaning most public SaaS companies don’t actually hit the 40% threshold.
Early-stage vs growth-stage
The Rule of 40 was designed for companies with some scale, typically $5M+ ARR. At earlier stages it can be misleading.
A seed-stage company growing 300% year-over-year with -250% margins scores 50%, which looks healthy by the Rule of 40. But the business is burning cash at an extreme rate, and the growth is off a tiny base. The metric doesn’t capture that nuance.
For bootstrapped SaaS founders in the $10K-$100K MRR range, the Rule of 40 is more useful as a directional guide than a hard benchmark. We’ve seen founders fixate on hitting the 40% threshold when they’d be better served watching their trend line. If your combined score is climbing quarter over quarter, you’re doing something right. The absolute number matters less than the trajectory.
Once you cross $1M ARR and your growth rate stabilises, the Rule of 40 starts to become a meaningful comparison tool.
Limitations
The Rule of 40 is popular because it’s simple. It’s also limited because it’s simple.
It doesn’t distinguish between revenue-quality types. A company with 120% net revenue retention and one with 80% NRR could have the same Rule of 40 score, but the first has a far more durable business. NRR tells you whether your growth is sustainable. The Rule of 40 doesn’t.
It treats all growth as equal. Organic growth from word-of-mouth is fundamentally different from growth fueled by $2M/month in paid acquisition. Both show up the same way in the formula.
It also ignores capital efficiency. Two companies might both score 50%, but one raised $100M to get there and the other raised $5M. The Rule of 40 can’t tell them apart.
In our experience, the companies that get the most out of this metric use it alongside three or four others, not in isolation. Pair it with NRR, churn rate, CAC payback period, and burn rate for a more complete picture. Our SaaS valuation calculator factors in several of these metrics together.
Calculate your score
How much your revenue has grown compared to a year ago. If you were doing $80K ARR last year and $100K now, that's 25%.
Revenue minus all operating expenses, as a percentage of revenue. If you're doing $100K ARR and spending $120K, that's -20%.
Rule of 40 score
45%
Above 40%. You're in healthy territory. Investors and acquirers view this favourably.