What is the SaaS Rule of 40?
The SaaS Rule of 40 is a composite performance metric that adds a company’s revenue growth rate to its profit margin to assess whether growth and profitability are in a healthy balance.
A score at or above 40% signals attractive value creation, strong unit economics, and usually better valuation multiples, while a score below 40% can indicate inefficient growth, weak cash generation, or a need to revisit CAC payback, LTV:CAC ratio, and operating leverage.
Formula
In practice, the profit margin term is often EBITDA margin, operating margin, or free cash flow margin for more mature SaaS and recurring revenue companies, as long as the definition stays consistent over time.
Example
Imagine a SaaS business with 30% year-over-year revenue growth (based on ARR or MRR) and a 15% operating margin.
Using the formula:
A 45% score sits above the 40% threshold, suggesting the company is balancing expansion and profitability well, likely supporting healthy enterprise-value-to-revenue multiples.
If the same company were growing 25% with a –5% EBITDA margin, the Rule of 40 would be a warning sign that growth may be too expensive and that management should tighten costs, improve retention and net revenue retention (NRR), and optimize CAC payback before pushing for more top-line growth.