VC Metrics & Performance
What is the Rule of 40 for SaaS companies?
The Rule of 40 states that a healthy SaaS company's growth rate plus profit margin should equal at least 40%, balancing growth and profitability.
The Rule of 40 is a benchmark used to evaluate the health and efficiency of SaaS businesses. The idea: a SaaS company should have its revenue growth rate plus its profit margin (typically EBITDA or free cash flow margin) equal to at least 40%.
Formula: Revenue growth rate (%) + Profit margin (%) ≥ 40
Examples: - Growing at 60% YoY with -20% EBITDA margin = 40. Passes. - Growing at 30% YoY with 15% EBITDA margin = 45. Passes. - Growing at 20% YoY with 5% EBITDA margin = 25. Below 40 — concerning.
Why it matters: Early-stage companies can violate the Rule of 40 because they're burning cash to grow fast. That's expected. But as a company matures (typically $50M+ ARR), investors expect it to approach or exceed 40. Companies trading at premium valuations almost always pass this test.
Public market context: SaaS companies that pass the Rule of 40 trade at significantly higher revenue multiples than those that don't. It's become a standard screening criteria for growth equity and late-stage investors.
Limitations: The Rule of 40 is a blunt instrument. It doesn't tell you why a company is or isn't at 40. A company growing at 20% with 20% margins is very different from one growing at 100% with -60% margins, even if both score 40 on the rule.
Related questions
What startup metrics do VCs care about most?
VCs focus on growth rate, revenue, burn rate, CAC/LTV, churn, and net dollar retention — the specific metrics depend on the stage and business model.
What is IRR in venture capital?
IRR (Internal Rate of Return) is the annualized return on a VC investment, accounting for the timing of cash flows. Top-quartile VC funds target net IRRs above 20-25%.
What is TVPI and MOIC in venture capital?
TVPI (Total Value to Paid-In Capital) is the total value of a fund including unrealized gains. MOIC (Multiple on Invested Capital) is the gross investment multiple on a deal or fund.