Rule of 40: Everything You Should Know [2025]
6/2/2025 | 9 min
If you're like many SaaS businesses, your focus is likely on customer acquisition and retention to drive growth. However, concentrating solely on growth rates without considering profit margins or persisting with the same strategies regardless of results - can hinder your progress at key milestones.
Introducing the Rule of 40: a vital metric for assessing the financial health of SaaS companies. It serves as a benchmark to balance growth and profitability, guiding strategic decisions for sustainable success.
What is the Rule of 40?
The Rule of 40 is a financial benchmark commonly used in the SaaS and software industry to determine a company’s growth-profits balance. It asserts that the sum of a company’s revenue growth rate and profit margin should be at least 40%.
For example, a company growing at 10% should ideally report a 30% profit margin to meet the benchmark.
The term gained popularity through venture capitalist Brad Feld. According to a McKinsey report, software companies that maintain a Rule of 40 score above the threshold are more likely to achieve better valuations.
Rule of 40: Formula
Rule of 40 = Revenue Growth Rate (%) + Profit Margin (%)
Revenue Growth Rate: Calculated year-over-year (YoY), reflecting the company’s ability to scale.
Profit Margin: Commonly measured using EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
Example
Revenue in 2022: $5.7M
Revenue in 2023: $8M
Growth Rate = (($8M - $5.7M) / $5.7M) × 100 = 40%
EBITDA in 2023 = $400,000
Profit Margin = ($400,000 / $8M) × 100 = 5%
Rule of 40 Score: 40% + 5% = 45%
This result exceeds the threshold, showing a healthy business balance.
Why the Rule of 40 Matters
Here’s why top investors and SaaS leaders trust this metric:
Investor Confidence: The Rule of 40 is widely used by VCs and private equity firms to evaluate SaaS companies, particularly when comparing growth-stage businesses. According to TechCrunch, high-growth companies that can maintain strong profit margins are seen as more sustainable in the long run.
Financial Health Check: It serves as a litmus test - if you're well above 40%, you're operating efficiently.
Strategic Planning: Helps teams know when to focus on scaling vs. cutting burn rates.
Rule of 40 vs. Rule of 50
The Rule of 50 is an even stricter variant - often used to assess late-stage SaaS companies preparing for IPOs. It suggests that only top-tier software firms (with elite margins or explosive growth) can achieve this benchmark.
In the Bessemer Venture Partners’ Cloud Index, companies with higher Rule of 40 scores consistently earned premium valuations.
The 40/40/20 Rule
This rule applies less as a metric and more as a budgeting framework:
40% of budget on growth
40% on core operations and profitability
20% on R&D and innovation
It ensures strategic balance and sustainable scaling - particularly in product-led companies.
Real-World Examples
Salesforce (2022):
Growth Rate: ~25%
Operating Margin: ~30%
Rule of 40 Score: 55% (source)Zoom (2020 pandemic boom):
Growth Rate: 355%
Operating Margin: 41.7%
Rule of 40 Score: 396% (source)
📘 Additional Insights on SaaS Financial Metrics
🔍 Understanding the Rule of 50
The Rule of 50 is a more stringent benchmark than the Rule of 40, suggesting that a SaaS company's combined revenue growth rate and profit margin should equal or exceed 50%. Achieving this indicates exceptional operational efficiency and growth potential, often attracting higher valuations from investors. While not all companies can meet this threshold, those that do are considered top performers in the industry. The SaaS Rule of 40 Explained
📊 The 40/40/20 Rule in Business Strategy
The 40/40/20 rule is a strategic framework allocating resources as follows:
40% to customer acquisition
40% to customer retention
20% to upselling and cross-selling
This approach ensures a balanced focus on expanding the customer base, maintaining existing relationships, and increasing revenue per customer.
💼 The 60/40 Rule in Investment Portfolios
In investment strategies, the 60/40 rule refers to a portfolio allocation of 60% equities and 40% fixed-income securities. This mix aims to balance risk and return, providing growth through stocks and stability through bonds. While not directly related to SaaS, understanding such financial principles can aid in broader business financial planning.
How Outsource Work Can Help
At Outsource Work, we offer outsourced CFO services and real-time financial dashboards to help SaaS startups track profitability, CAC, LTV, and of course - your Rule of 40.
Our tools help SaaS founders:
✅ Calculate revenue growth automatically
✅ Track profit margins with clean, up-to-date dashboards
✅ Benchmark against the Rule of 40, 50, or custom thresholds
✅ Forecast long-term sustainability and raise capital with confidence
FAQs
What is the Rule of 40 formula?
Rule of 40 = Revenue Growth Rate (%) + Profit Margin (%)
How do I calculate my SaaS profit margin?
Use EBITDA divided by total revenue, then multiply by 100.
Is the Rule of 40 still relevant in 2025?
Yes. According to recent Forbes research, it's even more important in today’s cautious investment climate.
Can I meet the Rule of 40 with a negative profit?
Yes, if growth is explosive (e.g. 60% growth and -20% EBITDA = 40%).
What is a good SaaS profit margin?
According to SaaStr, top SaaS companies maintain 70-80% gross margins and 10–30% EBITDA margins.
What is the Rule of 40 in SaaS?
The Rule of 40 is a performance metric for SaaS companies, stating that the sum of a company's revenue growth rate and profit margin should be at least 40%. This balance indicates healthy growth and profitability.
How is the Rule of 40 calculated in SaaS?
It's calculated by adding the year-over-year revenue growth rate (%) to the profit margin (%), often using EBITDA margin for profitability.
What is the Rule of 50?
The Rule of 50 is an elevated benchmark suggesting that a SaaS company's combined revenue growth rate and profit margin should equal or exceed 50%, indicating exceptional performance.
What does '40over' refer to in SaaS?
'40over' typically refers to companies exceeding the Rule of 40 benchmark, showcasing strong growth and profitability metrics.
Can you explain the 40/40/20 rule?
Yes, it's a strategic allocation where 40% of efforts/resources focus on customer acquisition, 40% on retention, and 20% on upselling/cross-selling, aiming for balanced business growth.
How do SaaS profit margins impact the Rule of 40?
Higher profit margins contribute positively to the Rule of 40 calculation, allowing for slower growth rates while still meeting the benchmark.
What are typical SaaS growth rates?
Growth rates vary, but early-stage SaaS companies often aim for 20-50% annual growth, while mature companies may target 10-20%.
How does EBITDA relate to SaaS companies?
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a measure of operational profitability, commonly used in the Rule of 40 calculation for SaaS businesses.
What is the significance of recurring revenue margins?
Recurring revenue margins indicate the profitability of subscription-based income, crucial for SaaS companies relying on consistent revenue streams.
Are there other rules similar to the Rule of 40?
Yes, frameworks like the Rule of 50 and the 60/40 investment rule offer alternative benchmarks for evaluating financial health and strategy.
