Rule of 40
SaaS companies exceeding Rule of 40 trade at 2x higher revenue multiples than those below. Only 25% of public SaaS companies consistently exceed 40% (Meritech 2024).
💡TL;DR
Rule of 40 = Revenue Growth % + EBITDA Margin %. Target: ≥40%. Examples: 50% growth + -10% margin = 40 ✓, 20% growth + 25% margin = 45 ✓, 15% growth + 10% margin = 25 ✗. Investors use this to evaluate SaaS efficiency. Early-stage: prioritize growth (high growth, negative margin). Later-stage: balance toward profitability. Rule of 40 is the minimum bar for healthy SaaS.
Definition
A SaaS health metric where Revenue Growth Rate + Profit Margin should equal or exceed 40%. A company growing 30% with 10% margin hits 40. It balances growth investment against profitability, showing sustainable business performance.
🏢What This Means for SMB Teams
For bootstrapped SMB SaaS, Rule of 40 is critical since you can't burn indefinitely. Aim for positive margin + reasonable growth. 20% growth + 15% margin (35%) is respectable for self-funded companies.
Track MRR, churn, CAC payback—AI acts when metrics slip.
Metrics that matter, actions that move them.
📋Practical Example
A 50-person vertical SaaS was growing 25% YoY with -15% EBITDA margin (Rule of 40 = 10). Investors flagged unsustainable economics. They analyzed spend: 40% of marketing budget went to low-ROI channels. They cut inefficient spend, raised prices 12% for new customers, and focused on expansion revenue. After 12 months: growth held at 22% but margin improved to +8%, achieving Rule of 40 = 30. While still below 40, the trajectory satisfied investors for bridge funding.
🔧Implementation Steps
- 1
Calculate trailing 12-month revenue growth rate (YoY comparison).
- 2
Determine EBITDA margin (or free cash flow margin for more conservative view).
- 3
Add growth rate + margin to get Rule of 40 score.
- 4
Benchmark against stage: <$10M ARR focus on growth, >$50M ARR balance toward profit.
- 5
Track Rule of 40 quarterly and set targets for improvement path.
❓Frequently Asked Questions
Which margin should I use for Rule of 40?
EBITDA margin is standard. Some use operating margin or FCF margin for more conservative views. Be consistent with how you report to investors. For early-stage, EBITDA is most common.
Is Rule of 40 relevant for early-stage startups?
Less so at pre-Series A. Focus on growth and product-market fit. Rule of 40 becomes more relevant post-Series A when balancing growth efficiency matters. Still, tracking it early builds good habits.
⚡How Optifai Uses This
Optifai displays Rule of 40 components in executive dashboards, helping balance growth investments against profitability targets. Revenue Ledger shows how specific actions contribute to growth without proportional cost increases.
📚References
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Related Terms
ARR (Annual Recurring Revenue)
The annualized value of recurring subscription revenue. ARR = MRR × 12. It represents the yearly run-rate assuming no growth or churn, used for valuation, planning, and investor communication.
NRR (Net Revenue Retention)
The percentage of recurring revenue retained from existing customers after accounting for expansion, contraction, and churn. NRR = (Starting MRR + Expansion - Contraction - Churn) ÷ Starting MRR × 100. NRR >100% means you grow even without new customers.
CAC (Customer Acquisition Cost)
Total sales and marketing spend divided by new customers gained in a period. It includes media, tools, payroll, agencies, and overhead allocated to acquisition. Teams track CAC alongside payback period and LTV to know whether growth is profitable.
Revenue Forecast Accuracy
The percentage deviation between forecasted and actual revenue over a given period. Calculated as 1 - |Actual - Forecast| / Actual. High accuracy (within 5-10%) indicates healthy pipeline visibility and rep discipline; low accuracy suggests poor data hygiene or unrealistic projections.