The Rule of 40 is a quick health check for software companies: your growth rate plus your profit margin should add up to at least 40. It captures the trade-off between growing fast and making money, so a company can pass by doing mostly one or a balance of both.
How it works
Take your revenue growth rate over the past year as a percentage. Add your profit margin as a percentage, using a negative number if you are losing money. The total is your score.
A company growing 60% a year with a -20% margin scores 40. So does one growing 10% with a 30% margin. Both pass, even though they look very different.
Which profit measure to use varies. EBITDA margin and free cash flow margin are both common. Pick one and use it consistently when you compare periods.
A worked example
A SaaS business growing revenue by 30% a year with a 15% profit margin scores 45. That clears the benchmark by 5 points.
Questions people ask
Does the Rule of 40 apply to early-stage startups?
It is mainly used for more established SaaS companies with steady revenue. Very young companies can show huge growth percentages from a small base, which makes the score less meaningful.
What if my score is below 40?
It is a benchmark, not a pass or fail test. It is useful for asking whether the money you are losing is buying enough growth, or whether slower growth is being balanced by profit.
Should growth be ARR or revenue?
Either is used in practice. ARR growth is common for subscription businesses, while total revenue growth is more common in financial reports. Whichever you choose, keep it consistent.