Rule of 40

The Rule of 40 is a performance benchmark specific to software and subscription companies, whereby the sum of the revenue growth rate and the profitability margin should reach or exceed 40%. A company growing 30% with a 10% margin satisfies the rule, as does another growing 15% with a 25% margin.

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Its value is to balance two often-opposing objectives: growth and profitability. A young SaaS (Software as a Service) company may legitimately sacrifice margin to accelerate, as long as its growth compensates; a more mature company, whose growth slows, must in return improve its profitability. The margin used varies with practice, most often the EBITDA margin or the Free cash flow margin.

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By way of illustration, an editor grows 30% with an EBITDA margin of 12%: the sum reaches 42%, above the 40% threshold. A competitor growing only 15% would need to show at least 25% margin to satisfy the same rule.

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The Rule of 40 is a quick filter, not a valuation method: it informs the reading of the ARR multiple (SaaS valuation) by signalling whether the growth on display comes with a sustainable business model. Durably clearing this threshold is a recognised factor of valuation premium for software editors.