Rule of 40
The Rule of 40 states that a healthy SaaS company's revenue growth rate plus profit margin should equal or exceed 40%. A company growing 60% with -20% margins scores 40 (passing). A company growing 20% with 25% margins scores 45 (also passing). It balances growth against profitability.
Saved Annually
Operational efficiency improvements that directly improve margins
Why Rule of 40 Matters for SaaS Companies
The Rule of 40 forces the conversation investors increasingly demand: are you growing efficiently? Pure growth at any cost stopped being rewarded after 2022. For Series B companies, this metric is now table stakes in fundraising conversations. Scoring above 40 signals you can grow without burning unlimited cash.
Formula
Rule of 40 Score = YoY Revenue Growth Rate (%) + EBITDA Margin (%)
Benchmark
Passing: 40+. Good: 40-60. Exceptional: 60+. Most early-stage companies score below 40 (and that is okay).
Tools for Measurement
An Operator's Take
I use the Rule of 40 as a strategic compass, not a rigid target. At the Seed stage, scoring below 40 is expected — you should be investing heavily in growth. But by Series B, you need a credible path to 40+. The most common pattern I see: a company growing 35% YoY with -25% margins (scoring 10). They think they need more revenue. Usually, the fix is operational efficiency — reducing CAC, automating manual processes, fixing revenue leakage. At BatchService, automating billing alone saved 540 hours annually. That is headcount you do not need to hire, which directly improves margins.
Common Mistakes
What I see go wrong at Seed to Series B companies.
Obsessing over the Rule of 40 at Seed stage. Early-stage companies should prioritize growth. The Rule of 40 becomes relevant at Series B+.
Using GAAP revenue instead of ARR growth rate. The Rule of 40 should use recurring revenue growth to be meaningful for SaaS.
Only trying to improve the growth side. Efficiency improvements (better margins through automation, pricing, reduced churn) are often easier wins than incremental growth.
What to Do This Week
Concrete steps you can take right now.
Calculate your current Rule of 40 score. If you are pre-Series B and below 40, that is expected — focus on growth.
If you are approaching Series B and score below 30, identify the biggest efficiency lever: is it CAC reduction, churn improvement, or operational cost savings?
Model your path to 40+. What combination of growth rate and margin improvement gets you there in 12-18 months?
Related Resources
Try These Tools
Further Reading
Frequently Asked Questions
Is the Rule of 40 still relevant?
Yes — arguably more relevant than ever. After 2022, investors shifted from pure growth to efficient growth. The Rule of 40 is the standard framework for evaluating that balance. Public SaaS companies trading at premium multiples consistently score above 40.
What if my Rule of 40 score is below 40?
For Seed and Series A companies, a low score is normal — you should be investing in growth. For Series B+, scoring below 40 limits your fundraising options. Improve by either accelerating growth (better go-to-market, reducing churn) or improving margins (operational efficiency, pricing optimization, reducing CAC).
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