# Rule of 40

**Category:** metrics  
**Short Description:** A SaaS health benchmark stating that revenue growth rate plus profit margin should exceed 40%.  
**Last Updated:** 2026-06-09T00:00:00Z

## Definition

The Rule of 40 is a heuristic for evaluating the health of a software business: a company's annual recurring-revenue growth rate plus its profit margin (commonly EBITDA or free-cash-flow margin) should sum to at least 40%. Popularized among SaaS investors (often attributed to Brad Feld), it captures the core trade-off between growth and profitability — a company can grow fast and burn cash, or grow modestly while highly profitable, but the combination should clear the 40% bar. It is most reliable for scaled, mature SaaS businesses rather than early-stage startups.

## Formula

**Formula:** `Growth Rate (%) + Profit Margin (%) ≥ 40%`
**Result Unit:** %

Your growth rate and profit margin together should add up to at least 40.

## Calculation

**Formula:** `Rule of 40 = Revenue Growth Rate (%) + Profit Margin (%) ≥ 40%`

**Explanation:** Add the year-over-year recurring revenue growth rate to the profit margin (EBITDA or free-cash-flow margin). If the sum is 40 or higher, the company is considered healthily balanced between growth and profitability. A high-growth company can carry negative margin and still pass; a slow-grower must be highly profitable to clear the bar.

### Components

- **Revenue Growth Rate**: Year-over-year recurring revenue growth rate, as a percentage
- **Profit Margin**: Profitability margin, typically EBITDA or free-cash-flow margin, as a percentage

## Industry Benchmarks

| Segment | Typical Range | Median | Notes |
| --- | --- | --- | --- |
| Public SaaS (median) | ≈34% (LTM) | 34% | More than half of public SaaS companies do not currently clear the Rule of 40. |
| Passing threshold | ≥40% | 40% | 40+ is considered healthy across company sizes; top performers reach 50–60%+. Some investors instead use a 'Rule of X' that weights growth ~2–3x free-cash-flow margin (Bessemer). |

**Sources:** Meritech Capital benchmarks, Aug 2024, Brad Feld / widely adopted SaaS investor heuristic

## Examples

- Growth 30% + EBITDA margin 15% = 45 → passes the Rule of 40
- Growth 60% + margin −15% = 45 → passes despite burning cash, because growth is high
- Growth 20% + margin 10% = 30 → fails; the company needs more growth or more profit

## How AdSights Helps

**Tracking Rule of 40:** The Rule of 40 forces a choice between growth and efficiency — and acquisition is where both are won or lost. By revealing which creatives and audiences acquire customers most efficiently, AdSights helps teams protect the margin side of the equation without throttling growth. Cutting waste from underperforming ad variants improves profitability; concentrating spend on proven, scalable creative sustains growth — moving both terms of the Rule of 40 in the right direction at once.

## FAQs

### What is the Rule of 40?

The Rule of 40 is a SaaS health benchmark stating that a company's revenue growth rate plus its profit margin should add up to at least 40%. It encodes the trade-off between growth and profitability: you can grow fast while burning cash, or grow slowly while highly profitable, but the two together should clear 40. Investors use it as a quick gauge of whether growth is being bought at a sustainable cost.

### How is the Rule of 40 calculated?

Add the year-over-year recurring revenue growth rate (as a percentage) to the profit margin (typically EBITDA or free-cash-flow margin, also a percentage). If the sum is 40 or more, the company passes. For example, 30% growth plus a 15% margin equals 45, which clears the bar; 60% growth with a −15% margin also equals 45 and passes, because rapid growth offsets the loss.

### Is the Rule of 40 still relevant?

It remains a useful shorthand, but it has critics. The public-SaaS median was around 34% in 2024 (Meritech), meaning most companies fall short in a tighter market. Some investors, including Bessemer Venture Partners, advocate a 'Rule of X' that weights growth roughly 2–3x more than margin, on the logic that growth compounds over time while a margin gain is a one-period benefit. It's also less meaningful for early-stage companies than for scaled ones.

### Which profit margin should I use?

EBITDA margin and free-cash-flow margin are the two most common. Free-cash-flow margin is often preferred because it reflects real cash generation including the timing of subscription billings, while EBITDA is simpler and more widely reported. Whichever you choose, apply it consistently and pair the headline number with the underlying components — a 45 driven by 60% growth and a −15% margin tells a very different story than 30% growth at 15% margin.

## Related Terms

### Component Terms

- **[Annual Recurring Revenue (ARR)](/resources/glossary/metrics/annual-recurring-revenue-arr)**: ARR growth rate is the growth half of the Rule of 40
- **[Customer Acquisition Cost (CAC)](/resources/glossary/metrics/customer-acquisition-cost-cac)**: Acquisition efficiency directly affects the margin side of the rule

### Similar Terms

- **[Net Revenue Retention (NRR)](/resources/glossary/metrics/net-revenue-retention-nrr)**: High NRR fuels efficient growth that helps clear the Rule of 40
- **[Marketing Efficiency Ratio (MER)](/resources/glossary/metrics/marketing-efficiency-ratio-mer)**: Efficient spend improves margin without sacrificing the growth term