SaaS metrics guide
The Rule of 40
It is a heuristic, not a law — it was invented as a sanity check for public software companies and then applied to start-ups it was never designed for. Used correctly it is a useful guardrail; used carelessly it rewards the wrong behaviour.
Last updated 2026-10-20
The formula
Rule of 40 = revenue growth rate (%) + profit margin (%)The growth rate is year-over-year revenue growth. The margin is the ambiguous part, and the choice matters:
- Free cash flow margin — the original formulation for public companies. Hardest to manipulate, least available to a private start-up that does not track it.
- EBITDA margin — most common in practice. Ignores capex and working capital.
- Operating margin — includes capex through depreciation, so it is stricter.
Pick one and keep it. Switching between them year to year is how a business that fails the rule in March passes it by December without anything changing.
Worked example: $2.0m ARR last year, $2.6m this year is 30% growth. If the business spent $60k more than it earned, that is a −2.3% FCF margin. Rule of 40 score: 27.7 — below the line, which is normal for a company prioritising growth.
What the score means
| Score | Reading |
|---|---|
| 60+ | Exceptional. Usually a category leader with pricing power. |
| 40–60 | Healthy. The business can grow and still fund itself. |
| 20–40 | Mixed. Acceptable while investing, concerning if it persists. |
| Below 20 | Either the growth has stalled or the losses are structural. |
A score below 40 is not a failure. A company at 70% growth and −30% margin scores 40 exactly, and that is the intended answer: spending aggressively to grow is fine if the growth is real.
Where the rule breaks down
It punishes deliberate investment. A business hiring a sales team ahead of demand has a bad margin this year and higher growth next year. The rule reads the first year as a warning and misses the second.
It treats all growth as equal. 25% growth with 110% NRR is a compounding base. 25% growth with 75% NRR is a treadmill that needs ever more acquisition spend. Same score, different businesses.
Small numbers distort it. Going from $200k to $400k is 100% growth and scores well even if the absolute business is tiny. Below roughly $1m ARR the percentages are noise.
It ignores capital efficiency. Growth bought with $3 of equity for every $1 of new ARR satisfies the rule and destroys returns. The Rule of 40 says nothing about how the growth was funded.
It is not a valuation model. It was popularised as a screening heuristic for public software. Passing it does not make a company investable, and failing it does not make one uninvestable.
How to use it without being ruled by it
Use it as one signal among four:
- Rule of 40 — is the growth/profit trade-off sane for our stage?
- NRR and GRR — is the base compounding or leaky?
- CAC payback — how long is our cash tied up per customer?
- Runway — how many months do we have to prove it?
A company can pass the Rule of 40 and still be nine months from insolvency if its cash conversion is poor. It can fail the Rule of 40 and be in excellent shape if it is deliberately investing a large cash buffer into a market it is winning.
The honest use is directional: calculate it every quarter with the same definition, and treat a falling score as a question to investigate rather than a verdict to act on.
Run the numbers yourself
Startup Runway Calculator — free, no signup, results computed in your browser.
Open the Runway calculator →Frequently asked questions
What is the Rule of 40 for SaaS?
It says a SaaS company’s revenue growth rate plus its profit margin should total at least 40. A company growing 30% with a 10% margin passes; so does one growing 10% with a 30% margin. It expresses the trade-off between growth and profitability as a single screen.
Which margin should I use for the Rule of 40?
Free cash flow margin is the original public-company definition and the hardest to flatter. EBITDA margin is the most commonly used. Whichever you choose, apply it consistently across periods, because switching definitions changes the result by more than most operational improvements do.
Is failing the Rule of 40 bad?
Not by itself. Early-stage companies investing in growth routinely score below 40, and that is the intended trade-off. It becomes a problem when the score stays below 40 while growth is slowing — that combination means the losses are not buying future growth.
Does the Rule of 40 apply to start-ups?
Only loosely. It was built for public software companies with stable metrics and multi-year histories. Below about $1m ARR the growth percentages are dominated by small absolute numbers, so the score is noisy and should not drive decisions on its own.
Related guides
- Startup Runway: What It Means and How to Calculate ItRunway is cash divided by net monthly burn. Learn the formula, why net burn matters, the profitable-business case, and how much runway you should hold.
- MRR vs ARR: How to Calculate BothMRR is recurring revenue normalised to one month; ARR is MRR × 12. Learn the normalisation rules, what to exclude, and the mistakes that inflate both.
- SaaS Metrics Cheat SheetSix core SaaS metrics with their formulas, healthy benchmarks and links to free calculators: MRR, churn, LTV:CAC, CAC payback, quick ratio and runway.
Maintained by The SaaS Metrics Calculators Editorial Team
Maintained by the site’s editors, with every formula unit-tested and every benchmark traced to a published source
Formulas and benchmarks last reviewed October 2026.
This page is educational. Every figure is computed in your browser from the inputs you supply, and nothing is checked against your own accounts — treat results as a planning aid, not as financial advice.