Metrics & Performance
Rule of 40
A benchmark for SaaS company health stating that a company's revenue growth rate plus its profit margin should equal or exceed 40%.
The Rule of 40 provides a simple way to evaluate whether a SaaS company is balancing growth and profitability appropriately. A company growing at 60% YoY with a -20% EBITDA margin scores 40 (passes). A company growing at 20% with a 20% margin also scores 40.
The rule recognizes that high-growth companies can and should sacrifice profitability, but there should be a tradeoff — as growth slows, margins should expand. Companies that score above 40 are considered healthy; below 40 raises questions about efficiency.
In Practice
Salesforce in its high-growth years might have grown 40% YoY at -5% margins (Rule of 40 score: 35 — borderline). A mature SaaS like Adobe might grow at 15% YoY at 30% margins (score: 45 — healthy). A struggling SaaS growing at 15% with -20% margins scores -5 — trouble.
Why It Matters
Public market investors use the Rule of 40 to value SaaS stocks. Companies that consistently score above 40 command premium multiples. During the 2022 correction, companies below 40 saw the most brutal multiple compression.