What is Rule of 40? Definition, Formula & Benchmarks

What is rule of 40?

The Rule of 40 says a healthy SaaS company's revenue growth rate plus its profit margin should total at least 40%. Popularized by Brad Feld, it lets you trade growth for profitability, or the reverse, as long as the sum clears 40%. It's a fast read on balanced, efficient scaling.

Formula

Rule of 40 = Revenue Growth Rate (%) + Profit Margin (%)

Revenue Growth RateYear-over-year ARR or revenue growth
Profit MarginUsually EBITDA or free-cash-flow margin

Worked example

A startup growing ARR 60% year over year with a −25% EBITDA margin scores 60 + (−25) = 35%, just under the bar. Trim burn to a −15% margin and the score hits 45%, comfortably above 40.

Benchmarks by stage

40% is the baseline for a healthy SaaS company; above 40% signals a favorable growth-profitability balance.

< 20% · Weak

20–40% · OK

> 40% · Healthy

Source: Brad Feld / Wall Street Prep (2025)

Why it matters for fast-growing companies

For early-stage startups burning to grow, the Rule of 40 keeps growth honest, hyper-growth with runaway burn still fails the test. Investors use it to sanity-check whether your spend is buying enough growth, especially in tighter funding markets where efficiency is priced in.

Frequently asked questions

What counts as the profit margin in Rule of 40?+

Most commonly EBITDA margin, though free-cash-flow margin or operating margin are also used. Pick one and stay consistent. For early-stage startups the margin is usually negative, so high growth has to carry the score above 40%.

Does the Rule of 40 apply to seed-stage startups?+

It's most useful once you have meaningful, measurable ARR, typically post-Series A. Very early startups growing off a tiny base can post huge growth percentages that distort the score, so treat it directionally rather than as a hard gate before scale.

Rule of 40