Rule of 40
Rule of 40 a strategic metric that adds a company's annual recurring revenue (ARR) growth rate to its profit margin to assess overall business health and efficiency.
The Rule of 40 helps SaaS founders and investors quickly evaluate a company's balance between growth and profitability.
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How Rule of 40 Works
The Rule of 40 is a key performance indicator used primarily in the SaaS industry to assess a company's operational efficiency. By combining growth rate and profitability into a single metric, it provides a holistic view of a company's strategic performance.
Investors and founders use this metric to understand how well a company is balancing investment in growth with maintaining financial discipline. A score above 40% indicates a healthy, sustainable business model that can attract potential investors or acquirers.
The calculation is straightforward: ARR Growth Rate + Profit Margin (typically EBITDA margin). This simple formula reveals whether a company is achieving a sustainable balance between expansion and financial health.
Key Points
- •Combines growth rate and profitability into a single metric
- •Typically uses ARR growth rate and EBITDA margin
- •40% threshold indicates a healthy SaaS business
- •Helps investors and founders assess company performance
- •Applicable across different stages of company growth
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