Rule of 40
A benchmark that says growth rate plus profit margin should exceed 40% for a healthy SaaS company.
Definition
The Rule of 40 states that a healthy SaaS company's revenue growth rate plus its profit margin (typically EBITDA or free cash flow margin) should equal or exceed 40%. A company growing at 60% with a -20% margin hits 40%. A company growing at 20% needs a 20%+ margin. It helps balance the tradeoff between growth and profitability, and is widely used by investors to benchmark SaaS companies.
Why it matters
The Rule of 40 is one of the most commonly cited benchmarks by growth-stage investors. If your company exceeds 40, the valuation multiple is likely higher. If it is well below 40, expect pressure to either accelerate growth or cut costs.
Example
Company A grows at 50% with -5% EBITDA margin: 50 + (-5) = 45 (above 40, healthy). Company B grows at 15% with 10% margin: 15 + 10 = 25 (below 40, underperforming). Company B likely faces pressure from investors.