Rule of 40: The Ultimate KPI for Balancing Growth and Profitability
The Rule of 40 states that the sum of your growth rate and your EBITDA margin should be greater than or equal to 40%. It allows you to evaluate the balance between growth and profitability of a SaaS.
A company with 60% YoY growth and a negative EBITDA margin of 40% will be judged less healthy than another with 30% growth but 15% margin, through the lens of this Rule of 40.
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What is the Rule of 40?
The Rule of 40 is a performance benchmark for SaaS companies that states that the sum of your growth rate and your EBITDA margin should be greater than or equal to 40%.
Created by Brad Feld (VC investor at Foundry Group) in the 2010s, this rule allows for quick assessment of a SaaS's health. It makes sense because it allows different company profiles to be considered healthy: an Early-stage startup can display high growth with negative margins, while a Late-stage company will prioritize positive margins with more moderate growth. In both cases, achieving a score of at least 40% demonstrates a satisfactory balance.
Why does this rule exist?
The dilemma
Every SaaS company faces a trade-off: investing in growth degrades margins, while optimizing profitability slows growth. The Rule of 40 helps you know if you're finding the right balance.
What investors are looking for
Investors prefer a company displaying 50% growth with -10% margin (reaching 40%) rather than another with 15% growth and +10% margin (totaling 25%). The first demonstrates superior market potential, even if temporarily unprofitable.
Universal benchmark
The Rule of 40 allows comparison of SaaS at different stages:
| Size (ARR M€) | Growth | Margin | Rule of 40 |
|---|---|---|---|
| < 5 | +100% | -60% | 40% |
| 5-20 | +50% | -5% | 45% |
| > 50 | +20% | +25% | 45% |
All are "healthy" according to the Rule of 40, despite very different profiles.
Automate your Rule of 40 calculation
Interpreting your score
≥ 40%: Healthy balance
A score of at least 40% indicates a healthy balance between growth and profitability. Several profiles can reach this threshold: Hyper-Growth (80% growth, -40% margin), Balanced (40% growth, 5% margin), or Cash Machine (15% growth, 30% margin).
30-40%: Underperformance
A score between 30% and 40% signals underperformance. Low growth and low margin may reveal a Product-Market Fit problem. High growth but very negative margin requires validating unit economics (LTV:CAC ratio).
< 30%: Immediate action
A score below 30% requires immediate action. This may reveal churn that's too high (> 7% per month), poorly controlled CAC, or lack of Product-Market Fit. Analyze your Unit Economics and validate your PMF.
Trade-offs: growth vs profitability
The Rule of 40 allows three distinct approaches: Hyper-Growth (80% growth, -40% margin), typical of Seed/Series A; Balanced (40% growth, 5% margin), favored by Series B; and Profitable (15% growth, 30% margin), preferred in Late-stage or post-IPO.
Growth at All Costs Strategy
This approach suits winner-takes-all markets with validated unit economics (LTV:CAC > 3x) and 18+ months runway. A typical profile shows 100% growth and -60% margin. It facilitates fundraising and allows rapid market share capture, but involves rapid cash burn and dependence on successive fundraising rounds.
Balanced Growth Strategy
This strategy balances growth (40%) and margin (5%) to reach 45%. Ideal for mature markets preparing for Series B/C, it reduces dilution and strengthens resilience. Often the sweet spot for scale-ups.
Profit Maximization Strategy
This approach prioritizes margins (30%) over growth (15%), totaling 45%. It applies to saturated markets or in M&A/post-IPO context, offering solid margins and strong attractiveness to acquirers, at the risk of losing market share to more aggressive competitors.
Improving your Rule of 40
First lever: accelerate growth
Expansion Revenue via upsell (+50% MRR without acquisition), churn reduction (from 5% to 3% boosts LTV by +67%), acquisition acceleration (doubling new customers doubles growth), and geographic or vertical expansion (multiplies TAM).
Second lever: improve margins
CAC optimization via organic channels (SEO, referral), Gross Margin increase through automation (target > 80%), operational efficiency improvement (ARR per employee), and pricing power if high NPS (+10-20% direct impact on margins).
Rule of 40 by company stage
Pre-Seed to Seed | ARR < €1M
At this stage of development, the priority is validating product market fit with early traction. Tolerance for the Rule of 40 is higher, resulting in a benchmark in the 20-40% range.
Typical profile:
EBITDA Margin: -180%
To assess the quality of such a young startup, it's rather the LTV:CAC (>2.0x), MRR Churn (<7%), and CAC Payback (<18 months) that are central.
Series A | ARR €1-5M
The priority becomes scaling acquisition while reducing churn. The Rule of 40 benchmark is established between 35-50%, with increasing requirement on unit economics quality.
Typical profile:
EBITDA Margin: -50%
Signals such as R40 below 30%, churn above 5%, or CAC Payback over 18 months, indicate structural problems to fix before scaling further.
Series B to C | ARR €5-50M
The path to profitability becomes central. The expected Rule of 40 benchmark is 40-60%, with a clear trajectory to positive EBITDA within 12-24 months.
Typical profile:
EBITDA Margin: -5%
Investors scrutinize operational efficiency and the ability to progressively reduce losses while maintaining sustained growth.
Late-stage and Public | ARR > €50M
Profitability and sustainable growth become priorities. The Rule of 40 benchmark of 40-50% is strictly respected, with strong shareholder pressure on quarterly profitability.
Typical profile:
EBITDA Margin: +20%
The market expects predictable growth and robust margins, with demonstrated ability to generate cash consistently.