Definition
The Rule of 40 balances growth against profitability: a company can earn its score by growing fast, by being very profitable, or by a mix. It is most meaningful for companies past roughly $10M to $15M in revenue.
Formula
Rule of 40Rule of 40 score = Revenue growth % + Profit margin % (often free cash flow or EBITDA margin)
Example
A company growing 30% a year with a 12% free cash flow margin scores 42. A $3M ARR startup growing 60% while burning heavily may score below zero, which is normal at that stage.
Benchmarks
40 or above is strong. Public SaaS investors often reward companies above 40 with higher multiples.
Common mistakes
- Applying it to very early companies.
- Mixing EBITDA margin one quarter and free cash flow margin the next.
Examples use Demo Co, a fictional $3M ARR SaaS company, or a generic company where noted. Benchmarks are common reference points, not targets for every business.