Rule of 40
Definition
Composite SaaS health score that sums the company's revenue growth rate and a profitability proxy (commonly EBITDA margin or free-cash-flow margin) into a single percentage. Originally articulated by Brad Feld in 2015 and codified by the SaaS Metrics Standards Board, the rule frames the growth-vs-profitability tradeoff: a company growing at 60% with a −20% margin scores 40, equal to a company growing at 20% with a +20% margin. The board reads it to sanity-check whether growth is being bought at unhealthy burn or whether margin discipline is constraining growth too far. Common pitfall: which profitability proxy is used materially changes the score (FCF margin is the strictest, EBITDA more flattering, "operating margin" inconsistently defined), so pick one and disclose it next to the number.
Why it matters
Single-number readout of the growth-vs-burn tradeoff. Lets the board compare a high-growth / high-burn company to a slow-growth / profitable one on one axis, and surfaces unhealthy growth (high growth paid for with margin much worse than negative growth-rate offset).
How it's calculated
Rule of 40 = revenue_growth_rate (%) + profitability_margin (%). Per SMSB, `revenue_growth_rate` is typically YoY ARR or revenue growth; `profitability_margin` is typically EBITDA margin or FCF margin (disclose which). Both inputs are percentages — the output is also a percentage and can be negative when negative margin overwhelms growth. How to interpret it
Per the rule as originally framed by Brad Feld (2015) and the SaaS Metrics Standards Board, a score at or above 40% is the canonical "healthy" threshold for growth-stage SaaS; below 40% signals either growth or margin is under-delivering. Finer stratifications often cited (>50% strong, >60% best-in-class) are industry folk-wisdom, not citation-grade. Always disclose which profitability proxy is used — comparing an EBITDA-margin Rule of 40 to an FCF-margin Rule of 40 is apples-to-oranges and a frequent board-deck error.
Source
SaaS Metrics Standards Board · Rule of 40
Metric definitions reference standards published by the SaaS Metrics Standards Board (saasmetricsboard.com). imboard is not affiliated with, endorsed by, or a member of SMSB.
Benchmarks
| 25th percentile | Median | 75th percentile |
|---|---|---|
| -4 | 15 | 31 |
Higher is better. Source: KBCM/Sapphire SaaS Survey 2024 (15th Annual) (2024).
Stage relevance
Typically owned by
Related KPIs
Year-over-year percentage growth in ARR (or recognized revenue, if explicitly anchored) — comparing the current period to the equivalent period 12 months prior. The single most-watched investor metric and the largest single driver of SaaS valuation multiples. Common pitfall: comparing to the prior quarter (QoQ) and reporting it as "growth rate" — boards and investors mean YoY unless explicitly noted otherwise. Anchored to KBCM/Sapphire SaaS Survey 2024 §YoY ARR Growth for cross-company benchmarking.
Recognized revenue minus cost of goods sold (COGS), divided by recognized revenue, expressed as a percentage. The single best read on whether the business model can ever generate operating leverage — a low gross margin caps every downstream efficiency metric (CAC payback, LTV/CAC, Rule of 40). For SaaS, COGS includes hosting, third-party software, customer support, and customer-success cost-of-service. Common pitfall: omitting customer success from COGS inflates the margin and breaks comparability with peer benchmarks. Anchored to KBCM/Sapphire SaaS Survey 2024 §Gross Margin.
Average monthly net cash outflow over the reporting period — total cash spent minus total cash collected, divided by the number of months in the period. The headline survival number for venture-backed startups: it pairs with `finance.total_cash_in_bank` to produce runway, and pairs with revenue growth to produce the Bessemer "burn multiple". Common pitfall: net burn is volatile — large quarterly bills (annual SaaS renewals, employer-tax true-ups), enterprise prepayments, and FX swings can mask the underlying trend. Smoothing over a trailing 3-month average is standard board practice. Equally important: do not silently include one-off cash events (acquisitions, settlements, large prepayments received) without flagging them — boards prefer a "core burn" and "headline burn" pair when the period is noisy.
Estimated number of months the company can operate at the current net burn before unrestricted cash reaches zero, holding everything else constant. The single most consequential survival input for venture-backed companies — it sets the urgency of every fundraising, hiring, and cost decision. Common pitfall: runway is often quoted off `finance.total_cash_in_bank` and a single-month spot-burn instead of operationally-available cash and a 3-month-trailing burn — the result is a runway that looks 2–4 months longer than it actually is when working capital tightens. Boards should ask which cash and which burn went into the calculation.
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