If you had to pick one metric that quickly tells, whether a SaaS business is healthy or confused, it would be the Rule of 40.

Not because it is perfect.

But because it forces a hard conversation most teams avoid.

One Topic: Rule of 40

What Is the Rule of 40?

The Rule of 40 is beautifully simple. Add your annual revenue growth rate to your profit margin. If the total equals or exceeds 40%, you’re in good shape.

Growth Rate (%) + Profit Margin (%) ≥ 40%

That’s it. No complex formulas. No MBA required.

Let’s say your company grew 30% last year and your profit margin is 15%. That’s 45%. You are good. If you grew 25% but only made 5% profit, that’s 30%. You’re below the line.

Why Rule of 40 Number Matters

Brad Feld and Fred Wilson popularised this metric back in 2015. They noticed something interesting: SaaS companies that balanced growth and profitability attracted better valuations and survived market downturns.

The data backs this up. Companies meeting the Rule of 40 trade at 2.4 times higher valuations than those below the threshold. That premium has grown from 23% in 2022 to 140% in 2024. Investors are paying attention.

But here’s the reality check: only 32% of SaaS companies with over $5 million in revenue actually meet this benchmark. The median score? Just 12%. Most companies struggle to find this balance.

Multiple Paths to 40

What I love about this metric is its flexibility. You can reach 40% through different paths:

• 40% growth + 0% profit (high growth, burning cash)
• 30% growth + 10% profit (balanced approach)
• 20% growth + 20% profit (mature, profitable)

Each path represents a different company strategy. A startup might pursue aggressive growth with negative margins. A mature company might prioritise profitability over expansion. Both can hit 40%.

Shopify crushed it with 67% growth and 20% margins – an 87% score. Salesforce balanced 24% growth with 19% margins for a 43% score. Different strategies, both successful.

The Right Target for Your Stage

Don’t beat yourself up if you’re not at 40% yet. Your target should match your company stage.

• Early-stage companies ($0-10M revenue): Aim for 20-30%. You’re building foundations. Negative margins are acceptable if you’re growing fast.
• Scaling companies ($10-50M): Target 40-50%. Your sales model should be repeatable now. Start thinking about efficiency.
• Growth stage ($50-100M): Push for 45-55%. Balance becomes critical. Investors expect both growth and improving margins.
• Mature companies ($100M+): Maintain 40-45%. Growth naturally slows. Focus shifts to operational excellence and cash generation.

5 Ways to Improve Your Score

After studying dozens of successful SaaS companies, five levers that actually move the needle:

1. Expand existing customers. This is your highest-impact lever. Every 1% increase in net revenue retention flows directly to profitability. Top performers achieve 130%+ retention through upsells and cross-sells.
2. Reduce customer acquisition cost. Same growth, lower cost equals better margins. Optimise your marketing channels. Improve sales productivity. Target better accounts.
3. Improve gross margins. Optimise infrastructure costs. Automate support. Scale revenue without proportional cost increases.
4. Increase win rates. Close 5% more deals without spending more. Better qualification, stronger sales enablement, clearer differentiation.
5. Expand market penetration. Enter adjacent markets carefully. Geographic expansion or new segments can accelerate growth if done efficiently.

The Mistakes to Avoid

Companies game this metric and regret it later. Don’t optimise Rule of 40 while ignoring customer health. Don’t sacrifice everything for growth or cut growth too much for profitability.

And recommended to pick one profitability metric (EBITDA, free cash flow, or operating margin) and stick with it. Switching metrics quarter to quarter makes tracking impossible.

The Rule of 40 is one metric in your dashboard, not the only one. Track it alongside net revenue retention, customer acquisition cost, and gross margins.

Why This Matters Now

We’re in a different funding environment than five years ago. Investors aren’t throwing money at growth-at-any-cost anymore. They want sustainable businesses that can weather uncertainty.

Meeting the Rule of 40 isn’t just about better valuations. It’s about building a company that can survive bad markets and thrive in good ones. It’s about discipline, choosing growth opportunities that make financial sense while building a path to profitability.

Calculate your score today. Track it quarterly. Understand which lever will move your number most. And remember: 40 isn’t magic, but it’s a damn good target.

What’s your Rule of 40 score?

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Two Quotes to Inspire

Strategy without metrics is just hope. Metrics without action are just numbers.

Sustainable growth is not faster growth, it is smarter growth.

One Passage From My Bookshelf

The essence of strategy is not just deciding what to do, but deciding what not to do. When you have a clear hedgehog concept – a simple crystalline concept that flows from deep understanding – then you have a basis for making these decisions. Without such clarity, companies try to do too much and spread themselves too thin. They become mediocre at many things rather than truly great at the few things that matter most.

📚From “Good to Great: Why Some Companies Make the Leap and Others Don’t” by Jim Collins