Rule of 40

The Rule of 40 is a rule of thumb for subscription businesses: your revenue growth rate plus your profit margin should sum to at least 40%. It captures the trade-off every SaaS company makes between growing fast and being profitable, and gives investors a single number to judge whether that balance is healthy.

How it's calculated

Add your year-over-year revenue growth rate to your profit margin. Both are expressed as percentages, and the profit margin is usually a free cash flow margin or EBITDA margin.

For example, a company growing revenue 30% year over year with a 15% free cash flow margin scores 45 — comfortably above the threshold. A company growing 50% but burning cash at a -20% margin scores 30, and falls short despite faster growth.

Why it matters

The Rule of 40 exists because growth and profitability pull against each other. Early on, it's fine to grow fast and lose money; as a company matures, investors expect the margin side to carry more weight. The rule lets you compare a hyper-growth startup and a slower, cash-generating business on equal footing.

• A high-growth company can score well even while unprofitable.
• A slower-growing company needs strong margins to compensate.
• Consistently scoring below 40 signals that neither the growth engine nor the cost structure is working hard enough.

What it doesn't tell you

The Rule of 40 is a snapshot, not a diagnosis. It says nothing about why growth is slowing or where cash is going. Pair it with MRR trends, net revenue retention, and your burn rate and runway to understand the drivers behind the score rather than just the score itself.