What this calculator measures
The Rule of 40 is the standard screen for whether a SaaS company balances growth and profitability acceptably: revenue growth rate plus profit margin should reach 40. It formalises the trade markets are willing to make — losses are forgivable for enough growth, slow growth is forgivable for enough profit, but a company delivering neither is just expensive.
The formula
Both terms need definitions before the sum means anything. Growth: year-on-year recurring revenue growth (ARR growth for private companies, reported revenue for public ones). Margin: free cash flow margin is the most common basis; EBITDA and operating margin also circulate. The bases differ by enough to flip a verdict — a company can pass on EBITDA and fail on FCF in the same quarter.
Worked example
A company grows revenue 34% year on year with an 8% FCF margin: score = 34 + 8 = 42 — passes. A rival growing 55% while burning at a −20% FCF margin scores 35 and fails, despite growing faster: the rule prices its burn against its growth and finds the exchange rate poor.
What good looks like
Forty is the pass mark, not the podium. In recent public-SaaS surveys the median company has hovered in the high 20s to mid 30s — most listed SaaS companies fail the rule — while the top quartile clears 40 and elite compounders print 60+. Scores also travel with scale: the rule is calibrated for businesses beyond roughly $10M ARR, where the growth-profit trade is real rather than aspirational. Stage-by-stage context is on the benchmarks page.
Common mistakes
- Cherry-picking the margin basis. Quoting EBITDA when FCF fails is the oldest trick in the deck. Pick a basis, state it, keep it.
- Applying it to a seed-stage company. Pre-$10M ARR, the score mostly measures noise. Burn multiple and CAC payback are the stage-appropriate efficiency tests.
- Mixing periods. Quarterly annualised growth against a TTM margin produces a score belonging to no actual period. Same window for both terms.
- Treating 40 as a target to manage to. The rule is a screen, not a strategy. Cutting R&D to buy 5 margin points passes the test this year and fails the company in three.
FAQ
Which margin should the Rule of 40 use?
Free cash flow margin is the most common basis among public-market investors; EBITDA and operating margin are also used. The choice can move the score by 10+ points, so state the basis whenever you quote a score — and check it whenever you read one.
Does the Rule of 40 apply to early-stage startups?
Loosely at best. The rule was calibrated on companies beyond roughly $10M ARR. A seed-stage company burning heavily to grow 200% scores brilliantly; one growing 60% while burning modestly may fail — neither reading means much at that stage. Use burn multiple and payback instead.
Is growth or margin worth more in the score?
The formula weights them equally, but markets historically have not: a point of growth has commanded more valuation than a point of margin at high-growth companies. Some analysts use weighted variants for valuation work — the plain sum remains the standard health screen.