Rule of 40

The Rule of 40 is a rough heuristic for evaluating whether a SaaS company's balance of growth and profitability is healthy: add the year-over-year revenue growth rate to the profit margin (often EBITDA margin or free cash flow margin), and the sum should be roughly 40% or higher. A fast-growing but deeply unprofitable company and a slow-growing but highly profitable one can both satisfy the rule.

It's most useful as a directional benchmark for growth-stage and later companies, particularly public or pre-IPO SaaS businesses being compared on trading multiples — it's less meaningful for very early-stage startups still finding product-market fit, where growth rate volatility makes the math noisy.

The rule was written up by Brad Feld in a February 2015 post, where he described hearing it from a late-stage investor at a board meeting: growth rate plus profit should add up to 40%. Feld framed it for SaaS companies at scale — at least $50 million in revenue — and said he preferred EBITDA as the baseline profit measure, back-tested against the other margin definitions.

Pick one margin definition and stick with it. EBITDA margin is common for private companies; free cash flow margin is more conservative and common in public-company comparisons. Switching definitions between periods to flatter the score manufactures a trend that doesn't exist.

The rule is a screen, not a verdict. A company growing 90% with a -45% margin scores 45 but is burning heavily, and one growing 5% with a 40% margin also scores 45 but may be stagnating. Look at which input is doing the work and whether the trend is improving. Some investors also weight growth more heavily than margin when comparing valuations.