In the world of SaaS, where companies juggle between rapid growth and delayed profitability, the Rule of 40 imposed itself as a reference metric. By combining two key indicators, namely growth and margin, this rule synthesizes in a single figure the overall performance of a recurring model. It is now a standard used by investors to assess the quality of a business, far beyond gross turnover.
What does the Rule of 40 measures?
Rule of 40 (%) = Annual growth rate of the EBITDA or Operational cash flow margin
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Growth rate : generally based on the arr (annual recurring income) from one year to the next.
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Margin : often expressed in EBITDA, but sometimes on the margins of exploitation or cash flow of operations, according to the maturity of the company.
If the sum exceeds 40 %the company is considered balanced, efficient and potentially attractive for growth or late-teeth.
Why has the Rule of 40 become a standard in the SaaS?
It reconciles growth and discipline
In a model where growth can easily hide cost drifts, the Rule of 40 obliges to maintain a logic of efficiency. It values companies capable of growing without burning cash excessively.
It allows you to compare different models
A company with 70 % growth and -30 % margin is as “efficient” (score = 40) that a company with 10 % growth and 30 % margin. The important thing is balance, not the extreme.
It structures investors’ expectations
More and more late-teeting, business banks and corporate funds use the Rule of 40 as a quality initial filter in the evaluation or M&A processes.
It facilitates the predictability of the model
Companies that respect the Rule of 40 generally show a good command of their economic cycle, their economic units (CAC, LTV) and their trajectory towards profitability.
| Rule of 40 (%) | |
|---|---|
| <20 % | Unbalanced model, underperforming |
| 20 – 39 % | Transition to maturity, possible improvement margin |
| ≥ 40 % | Performance standard in the SaaS |
| > 60 % | Exceptional performance, rarely sustainable in the long term |
Example 1:
Annual growth of 50 % + EBITDA margin of –10 % = Rule of 40 = 40 %
Example 2:
20 % growth + EBITDA margin of 25 % = Rule of 40 = 45 %
Variants according to contexts
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In Early-Stagea negative rule of 40 is tolerable if growth is very strong (> 100 %) and supported by a controlled deployment strategy.
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In Series B or Crespect for the Rule of 40 becomes a prerequisite for any significant lifting or Ipoting the stock market by 24–36 months.
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Some versions incorporate the Free Cash Flow Margin Instead of EBITDA for a more conservative reading.
How to improve your Rule of 40 score
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Optimize operating margin
-Reduction of unit commercial costs (via automation, inbound, product-LED)
– rationalization of support and infrastructure functions
– Improvement of the gross margin -
Maintain sustainable growth
– Expansion on existing accounts (high NRR)
– positioning on verticals with high conversion
– Limit destructive value promotions -
Arbitrate investments according to their real impact
– Prioritization of projects with rapid effect on income
– suspension of expenses not correlated with growth or margin -
Pilot quarter per quarter
– Follow a rule of 40 slippery trajectory over 12 months
– Build a P&L with compared growth/margin scenarios
