The Rule of 40: How SaaS Investors Score Growth Against Profit
Grow 100% a year and you've earned the right to lose money. Grow 10% and you'd better be printing it. The Rule of 40 forces both stories onto one scale — here's how to compute it honestly, with founder-stated examples.
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Somewhere in 2015, SaaS investors converged on a single number to answer the oldest question in software: is this company growing responsibly, or just growing? The Rule of 40 — popularized by venture investors including Brad Feld, who wrote it up after hearing it at a board meeting — says a healthy SaaS company’s revenue growth rate and profit margin should sum to at least 40. Grow 100% a year and you’ve earned the right to lose money. Grow 10% and you’d better be printing it.
Growth rate (%) + profit margin (%) ≥ 40Year-over-year recurring-revenue growth plus EBITDA or free-cash-flow margin, both trailing-twelve-month.
Why one number, and why 40
The rule exists because growth and profit trade against each other, and every founder pitch exploits that trade in one direction. A company burning 40% of revenue looks reckless in isolation — unless it’s doubling. A company growing 8% looks stalled — unless a third of every dollar drops to the bottom line. The sum forces both stories onto one scale. Forty is not magic; it’s the empirical line above which SaaS companies have historically commanded premium multiples, and below which boards start scheduling harder conversations.
mParticle told us in late 2018 it was at a $36M run rate growing 100% year over year while tolerating 24-month CAC paybacks. Growth 100 + a deeply negative margin still clears 40 with room to spare.
Wistia bought out its investors with $17.3M of debt in 2017 and, in its founder’s words, the debt “forced us to be profitable.” Moderate growth plus a real margin clears the same bar from the other side.
How to compute it honestly
- Use recurring revenue growth — year over year, not a hot quarter annualized. The run-rate arithmetic that flatters a pitch deck also flatters this rule.
- Pick one margin and stay with it — EBITDA or free cash flow. Switching definitions quarter to quarter is how a 25 becomes a “40.”
- Match the periods — trailing-twelve-month growth against trailing-twelve-month margin. Spot growth against annual margin is a category error.
- Don’t net out what you capitalize — aggressive capitalization of engineering moves cost off the margin without changing the business.
What founders on the show actually report
The interviews are full of both routes to the line. Numerator described 2018 revenue heading past $130 million, up from just over $100 million — roughly 30% growth — while spending a disciplined 25% of revenue on sales and marketing under private-equity ownership: the profitable-grower profile. Expensify’s David Barrett described $60 million growing 50–100% with a famously tiny team — the rare company that clears 40 on both halves at once. And the growth-at-all-costs cohort of 2018–19 mostly cleared it on the growth term alone, which is exactly what the rule permits — as long as the growth is real and the churn underneath it doesn’t quietly eat the denominator.
The rule is a screen, not a strategy. Nobody builds a great company by managing to 40. It exists to catch the two failure modes — buying growth that never pays back, and harvesting profit from a product that stopped compounding. Score below 40 for a quarter and you have a story to tell; score below it for two years and you have a problem.
Where it breaks
Below roughly $10 million of revenue the rule mostly generates noise — small bases make growth rates spiky and margins meaningless. It also says nothing about quality of growth: a company hitting 40 with 130% net revenue retention and one hitting 40 with heroic outbound spend and 20% gross churn are not the same business, even if the arithmetic matches. Pair it with CAC payback and retention before believing it.
Used that way — one screen among three, computed on honest inputs — it remains the fastest read on whether a SaaS company’s growth is bought or earned.
SourcesFounder-stated figures from Nathan’s interviews: mParticle (November 2018), Wistia (2018, on the 2017 buyback), Numerator (November 2018), Expensify (December 2017). Rule attribution per Brad Feld’s 2015 essay.
