Rule of 40: A SaaS Benchmark That Still Predicts Who Wins
The Rule of 40 is a SaaS benchmark that says a healthy software company’s revenue growth rate plus EBITDA margin should total at least 40 percent. Popularized by Brad Feld in 2015, it gives investors one number to judge whether a business balances growth with profitability. In 2026, the median score across tracked SaaS companies sits near 12 percent.
What is the Rule of 40 in SaaS?
The Rule of 40 is a SaaS benchmark stating that a software company’s revenue growth rate plus profit margin should equal or exceed 40 percent. It gives investors and operators a single number to judge the balance between growth and profitability. A score above 40 percent signals financial health and stronger valuation multiple potential.
Who created the Rule of 40 and when?
Venture capitalist Brad Feld popularized the term in February 2015 in his post “The Rule of 40% for Healthy SaaS Companies.” A late-stage investor introduced it to him during a board meeting. David Cohen, his Techstars co-founder, also helped shape thresholds for when the rule applies in practice.
The idea stuck because it is simple, memorable and works for both founders and investors.
How do you calculate the Rule of 40?
Calculate the Rule of 40 by adding your revenue growth rate percentage to your EBITDA margin percentage. For example, 30 percent growth plus 15 percent EBITDA margin equals a score of 45. Use MRR or ARR for the growth input and EBITDA for profit in most SaaS cases.
Which revenue growth metric should you use?
Most SaaS companies use monthly recurring revenue (MRR) or annual recurring revenue (ARR). Here is how to get each number:
If subscription revenue is under 80 percent of your total revenue, use total revenue growth instead. Mixing recurring with one-time income skews the picture.
Which profit metric should you use for the Rule of 40?
EBITDA margin is the most common choice because it strips out non-cash costs like depreciation and amortization. It reflects core operating performance without tax or interest noise.
Alternatives include:
Pick one input and stick with it across reporting periods. Mixing methods breaks comparability.
What are real examples Rule of 40 formula?
The Rule of 40 formula is revenue growth rate plus EBITDA margin, with a target of at least 40. Four worked examples below show how very different profiles can all pass or fail the benchmark.
| Company | Growth Rate | EBITDA Margin | Score | Verdict |
| Company A | 15% | 35% | 50% | Profitable slower grower |
| Company B | 65% | -10% | 55% | High growth burning cash |
| Company C | 10% | 15% | 25% | Below benchmark |
| Company D | 30% | 20% | 50% | Balanced winner |
Company B and Company D both hit 50 but tell completely different stories. Context matters more than the final number.
What is the Weighted Rule of 40 and when should you use it?
The Weighted Rule of 40 gives growth more weight than profit. The typical formula is (1.33 × Growth) + (0.67 × EBITDA). Investors favor it for earlier-stage companies where robust earnings are not realistic yet.
| Version | Formula | Best For |
| Pure | Growth + EBITDA margin | Mature SaaS board reporting |
| Weighted | (1.33 × Growth) + (0.67 × EBITDA) | Early-stage growth heavy companies |
Use the pure version for boardroom conversations and the weighted version if growth is still your story.
When should a SaaS company start tracking the Rule of 40?
Start tracking the Rule of 40 once your SaaS reaches product-market fit and stable recurring revenue. Brad Feld suggests $1 million in MRR. David Cohen places the threshold at $15 to $20 million in ARR. Other investors use $50 million ARR. Before that, prioritize growth and unit economics.
| Stage | ARR | Realistic Target | Primary Focus |
| Early-stage | Under $5M | Not yet relevant | Product-market fit |
| Scale-up | $5M to $20M | Trending toward 40 | Balanced growth |
| Growth | $20M to $80M | 40+ expected | Capital efficient growth |
| Mature | Over $80M | 40+ consistently | Profitability discipline |
SaaS executive Dave Kellogg puts it well. Many companies target compliance too early, sacrifice growth in the process and hurt their valuations because they fail to deliver the high growth investors want to see.
Why does this Rule matter for SaaS valuation?
Because it correlates directly with valuation multiples. SaaS companies that beat the benchmark typically earn higher revenue multiples and stronger enterprise value. Software Equity Group research shows the valuation premium for
That matters in three situations especially:
Passing the benchmark does not guarantee a high valuation. Failing it almost always hurts the multiple you can command.
What is a good Rule of 40 score?
A score above 40 is healthy. 50 to 60 is strong. Above 60 puts you in the top 10 percent. See this table for better understanding.
| Percentile | Score |
| Top 10% | 60 and above |
| Top 25% | 45 to 60 |
| 2026 Median | Roughly 12 |
| Bottom 25% | Below 0 |
SaaS Capital data shows the 2026 median has contracted sharply because growth rates slowed across the sector. Public examples still clearing the bar include:
The lesson is that hitting 40 today puts you in rare company. A score of 25 to 35 is more common than most founders admit.
What are the limitations of the Rule of 40?
The Rule of 40 is a heuristic not a verdict. A company can score 50 with 80 percent growth and negative 30 percent margin and still be unstable. Common limitations to know:
Use the score as a starting point not the final answer.
What is the difference between the Rule of 40, Rule of 50, and Rule of 60?
The Rule of 40 sets the health threshold at 40. The Rule of 50 and Rule of 60 raise the bar for elite or top-decile SaaS companies. As markets mature and investors demand capital efficient growth, some now use the Rule of 50 as the new premium standard.
The progression roughly maps like this:
Aim for 40 first. Chase 50 once you scale. Hitting 60 consistently is reserved for the best-run public SaaS businesses.
Final Thoughts
Use the Rule of 40 as a directional signal not a verdict. Calculate it with consistent inputs, track it quarterly and pair it with CAC, LTV:CAC ratio, and gross revenue retention. In the AI era obsess over unit economics and gross margin quality as much as the score itself. Balanced, capital efficient SaaS companies still win premium valuations in 2026.
