Rule of 40
A benchmark stating that a software company's growth rate plus its profit margin should equal or exceed 40%.
FORMULA
Rule of 40 = Year-over-Year ARR Growth % + EBITDA Margin %Why it matters
The Rule of 40 provides a balanced view of a SaaS company's performance, recognizing that high growth requires cash burn, while slower growth must be offset by profitability. A company growing at 50% with a -10% margin hits the Rule of 40, as does a mature company growing at 15% with a 25% margin. Public market investors use this metric extensively to assign revenue multiples. In private markets, it serves as a sanity check against reckless growth. Consistently beating the Rule of 40 indicates a business model that scales efficiently without destroying enterprise value.
2025 BENCHMARK
Benchmarkit Q4 2025 data shows the median Rule of 40 score for private SaaS companies is 28%, with only top-quartile companies clearing the 40% threshold.
COMMON MISTAKES
- Using GAAP revenue growth instead of forward-looking ARR growth.
- Calculating margin using gross margin instead of EBITDA or Free Cash Flow margin.
- Applying the rule to very early-stage companies (under $5M ARR) where growth percentages skew the metric.