Rule of 40 Calculator

Add revenue growth rate to profit margin, both in percent, and you have the score. Venture capitalist Brad Feld popularized the SaaS rule of 40 in a February 2015 post that states it in one line: “your growth rate + your profit should add up to 40%.” A healthy SaaS company sits at 40 or above, and the rule of 40 SaaS investors quote today is still that same sum.

On the second tab, the calculator works out the company's revenue growth rate as (this year's revenue ÷ last year's revenue − 1) × 100. Most finance teams calculate the rule from annual recurring revenue, because a SaaS company's growth rate should track recurring revenue growth, the recurring revenue stream that renews each year, and leave out one-off revenue streams like implementation fees.

For growth measured over several years, the CAGR calculator turns a start and end figure into one annual rate. Profit margin is this year's profit ÷ this year's revenue × 100.

The devil's in the details on the profit metric. Feld named EBITDA margin as his baseline and conceded profit is harder to define than growth, listing operating income, net income and free cash flow as alternatives. McKinsey's 2021 study used free cash flow. Pick one and keep it for every time period you compare, since switching from EBITDA to net income moves the score with nothing changed in the business.

The Rule of X result follows Bessemer Venture Partners' January 2024 formula: growth rate × 2 + free cash flow margin. Bessemer puts the multiplier at about 2x for late stage private companies and 2-3x for public ones, on the reasoning that a margin gain from operational efficiency adds value once while a growth gain compounds.

A SaaS business booked $20,000,000 in annual revenue last year and $26,000,000 this year, with $3,900,000 of EBITDA. Revenue growth comes to 30% ($26M ÷ $20M = 1.30), and EBITDA margin comes to 15% ($3.9M ÷ $26M). The Rule of 40 score is 45, five points clear of the line.

The Rule of X for the same company is 75: 30 × 2 + 15. Now read the margin table under the results. Hold growth at 30% and the margin can fall to 10% before the score slips under 40. Slow to 20% growth and the company needs a 20% margin, Feld's own example. Push growth to 60% and it can run at a -20% margin and still score exactly 40, the case of rapid growth paid for with losses.

• Revenue growth rate: 30%
• EBITDA margin: 15%
• Rule of 40 score: 45 (gap to 40: +5 points)
• Rule of X: 75

The score is a heuristic for business health, a quick screen with no accounting standard behind it. Why a company grows sits outside the formula.

Two companies at 45 can differ on churn, gross margin, customer acquisition cost, average revenue per account and sales efficiency, which is why SaaS leaders read it next to other SaaS metrics: the SaaS quick ratio, net revenue retention and unit economics. SaaS businesses rely on all of these key metrics together when they raise capital.

The rule was built for the SaaS business model, where subscription revenue renews and margins rise with scale. It travels less well to other business models. Usage-based pricing and other new business models in the SaaS industry tie revenue to customer activity, so one year's growth can swing with usage as much as with sales.

Few companies clear it. KBCM Technology Group's 2021 private SaaS survey found 50 of 173 companies above $5 million in ARR met the Rule of 40, about 29%, with a median combined growth rate and margin of 19%. McKinsey's August 2021 analysis of software companies between 2011 and 2021 found they exceeded it only 16% of the time.

The payoff shows up in valuation multiples, for venture capital and public investors alike. Bain & Company's December 2018 study found software companies above the line carried valuations about double those below it. Those higher valuation multiples are the investor confidence a score above 40 buys. The enterprise value calculator shows what a higher revenue multiple means in dollars.

A single year can be a flash in the pan. Of the 86 companies Bain tracked, 40% beat the rule in 2017, but only 25% did it for three or more years between 2013 and 2017. Chart a few years of scores before drawing conclusions about sustainable growth, and expect early stage startups tripling revenue to post scores that fall once growth levels settle.

In a nutshell, the SaaS rule of 40 says a software company's revenue growth rate plus its profit margin should add up to 40% or more. It gives SaaS companies one number for growth and profitability together, so a SaaS business burning cash to grow fast and a slower, highly profitable one land on the same scale. Late stage growth investors use it as a first screen on private deals and on public SaaS companies alike.

Take your ARR growth rate for the last 12 months, add your EBITDA margin or free cash flow margin for the same time period, and compare the total to 40. A company whose annual recurring revenue grew from $10 million to $13 million, a 30% ARR growth rate, at a 12% EBITDA margin scores 42. To calculate the rule from monthly recurring revenue, compare MRR with the same month a year earlier. The rule of 40 calculator above runs the same math from percentages or raw figures.

Anything at 40 or above passes. The median private SaaS company above $5 million in ARR scored 19% in KBCM's 2021 survey, so a score in the 20s is par for the course, and clearing 40 put a company among the 29% of that sample that made it.

That's T2D3, from Battery Ventures' Neeraj Agrawal, who laid it out in TechCrunch in February 2015: once a company reaches about $2 million in ARR, it triples revenue two years running, then doubles it three years running. Growth at that pace keeps the score high even with a deep negative margin, which is why late stage growth investors lean on the Rule of 40 once growth slows.

Use the one your investors report. Feld's original post leaned on EBITDA margin, McKinsey's research used free cash flow, and Bessemer defines the Rule of X on free cash flow margin. EBITDA leaves out capital spending, so a company that capitalizes a lot of software development scores higher on EBITDA than on free cash flow.

Year-over-year ARR growth rate is the common choice. If you track monthly recurring revenue, compare this month's MRR with the same month a year earlier and use that percentage. Compounding a single month-over-month jump into an annual figure overstates growth for any company with a seasonal sales cycle or a one-off burst of expansion revenue.

Feld set it for companies at $50 million in revenue or more. At the growth stage, a startup growing rapidly off a small base can post 150% growth and a -100% margin, a score of 50 that reflects high growth and says little about financial health. Grading a seed company on it is barking up the wrong tree.

Early stage startups should prioritize growth and cash runway. Established SaaS companies, where growth has slowed, are where the rule tests financial discipline, and established companies growing 10% need a 30% margin to pass.

A few have their cake and eat it too. Bain found 18% of the companies consistently beating the rule did it with organic revenue growth below 10%, half grew between 10% and 30%, and a third grew faster than 30%. High revenue growth and high profitability together is rare, so most management teams pick which side to prioritize for their stage of the life cycle.

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