Rule of 40

The Rule of 40 says a subscription business's revenue growth rate plus its profit margin should be at least 40%. It measures the trade-off between growing fast and making a profit in one number.

How it's calculated

Add your year-over-year revenue growth rate to your profit margin, both as percentages. Most people use free cash flow margin or EBITDA margin.

A company growing 30% a year with a 15% free cash flow margin scores 45, which passes. A company growing 50% with a margin of -20% scores 30, which falls short even though it grows faster.

Why it matters

Growth and profit pull against each other. Young companies are expected to grow fast and lose money. As a company matures, investors expect more profit. The rule lets you compare a fast-growing startup with a slower, profitable business.

• A fast-growing company can pass while unprofitable.
• A slow-growing company needs strong margins to pass.
• Scoring below 40 year after year means growth is too slow for the costs.

What it doesn't tell you

The score doesn't explain why growth is slowing or where cash goes. To find the causes, look at MRR trends, net revenue retention, burn rate, and runway.