F · Unit economicsExternally proven

Rule of 40 (Toward 60)

Growth rate plus profit margin should add up to at least 40 percent; in a PE and interest-rate environment the bar shifts toward 60. Profit may be traded against growth, but the sum has to hold.

When you need this method

Your company is growing but burning cash, or it is profitable but barely growing. Either state can be rationalized on its own. Investors, especially in a mature or PE-adjacent context, demand a balance metric that disciplines growth and profitability in a single number.

Approach

  1. 1Add the ARR or revenue growth rate in percent and the profit margin (FCF or EBITDA basis, chosen consistently).
  2. 2Check the sum against the threshold: at least 40, increasingly 60 for PE maturity and profit discipline.
  3. 3If below, analyze which side is the real lever: inefficient growth or missing cost discipline.
  4. 4Use the metric as a guardrail for investment decisions, not as the sole objective.
  5. 5Watch GRR and NRR in parallel, because expansion can mask weak new business and churn.

Typical application

A typical case: a maturing B2B SaaS prepares for an ownership change toward PE. Growth and margin have so far been reported on separate board slides and optimized separately. Leadership switches to the combined metric and finds the company below the bar because growth is being bought with inefficient sales build-out. The consequence is not an austerity program but a deliberate shift from unprofitable segments to efficient ones, lifting the sum above the threshold.

Limits and counter-indications

The threshold is a convention, not a law of nature; it varies with the interest-rate environment, maturity and buyer type. Very young companies with small revenue should not be steered primarily by this metric. The choice of margin basis (FCF or EBITDA) changes the result and must be disclosed consistently.

How to measure impact

Sum of growth rate and profit margin in percent, tracked over time against the relevant threshold (40 or 60).

Related methods

Tools for this

Sources

  1. 1.King Fuei Lee: Evaluating Stock Selection in the SaaS Industry, The Effectiveness of the Rule of 40, Applied Finance Letters 13, 2024, S. 168–185 (opens in a new tab) · 2024 · academic and scholarly literature · describes the methodTests the Rule of 40 empirically on 1,771 SaaS companies worldwide from 2003 to 2022 and finds that the sum of revenue growth and margin (most effective with EBITDA margin) separates winners from losers; it validates the combined metric's discriminatory power, explicitly not the level of the 40 threshold, the author proposes a better-performing modified variant.
  2. 2.Is 60 the New (Rule of) 40? Setting a New Standard of Software Excellence, Bain & Company (opens in a new tab) · Bain & Company · 2022 · investment, consulting and analyst firms, industry bodies and public agencies · provides benchmark figuresEstablishes the rule as the sum of revenue growth and EBITDA margin, that most software companies miss it, and that leading vendors now reach values in the 60s and above.
  3. 3.Why the Rule of 40 is Becoming the Rule of 60, Dave Kellogg (Kellblog) (opens in a new tab) · Kellblog · 2026 · practitioner source · supports the underlying mechanismTraces the raising of the bar back to compressed valuation multiples in private equity and shows the shift from 40 percent growth plus 20 percent margin to 20 plus 40.
  4. 4.Brad Feld: The Rule of 40% For a Healthy SaaS Company, Feld Thoughts (Blog), Februar 2015 (opens in a new tab) · 2015 · practitioner source · supports the underlying mechanismOldest traceable formulation of the method: growth rate plus profit should add up to 40%, intended for software companies above roughly USD 50m in revenue. Feld himself credits an unnamed late-stage investor who described it as his firm's house rule in a board meeting, no derivation, no data, no justification for the number 40. Lee (2024) cites this very post as the origin.
  5. 5.Jonathan Shaw: Using the Venture Capital Rule of 40 to Predict SaaS Stock Returns, CMC Senior Theses, Claremont McKenna College, 2018 (Betreuer: Eric Hughson) (opens in a new tab) · 2018 · academic and scholarly literature · supports the underlying mechanismEarliest academic test of the rule, though an undergraduate thesis without peer review. Sobering result: high Rule of 40 scores beat low ones on gross returns, but no significant risk-adjusted alpha remains; the outperformance is largely explained by the strength of the SaaS sector as a whole. Full-text PDF restricted to Claremont affiliates; only title page and abstract are public.

Origin: Feld · Adapted from: Dave Kellogg (Rule of 60, 2017/2026); Brad Feld, Fred Wilson (2015)

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