The Rule of 40 in SaaS Explained
By Michael Chen | August 19, 2025
The Rule of 40 helps founders balance growth and profitability. If your growth rate plus profit margin equals 40% or more, investors consider your SaaS business healthy. A strong score also improves your story during diligence because it signals efficient capital allocation, pricing discipline, and customer loyalty.
What Is the Rule of 40?
Add your year-over-year revenue growth percentage to your profit margin. A combined score of 40 or higher shows that you are scaling efficiently. Public SaaS leaders typically sit between 35% and 60%, while bootstrapped products often post lower growth with higher margins.
| Company Type | Growth | Profit Margin | Rule of 40 Score | Typical EV/ARR |
|---|---|---|---|---|
| Bootstrapped, $1M ARR | 20% | 18% | 38 | 3.5x – 5x |
| VC-backed, $5M ARR | 45% | -5% | 40 | 6x – 9x |
| Efficient growth, $10M ARR | 32% | 15% | 47 | 9x – 12x |
Why It Matters
The metric gives investors a quick snapshot of risk. Fast-growing but unprofitable companies can still meet the Rule of 40, while slow-growth firms need stronger margins. Brokers use it as a screening tool to segment deal flow and to benchmark your efficiency against similar ARR bands.
| Input | Why Buyers Care | Quick Improvement |
|---|---|---|
| Gross churn | Predicts future net revenue retention and logo risk | Improve onboarding, add success playbooks, and set quarterly NPS targets |
| Net burn | Signals cash runway and dependency on new capital | Consolidate tools, reprioritize roadmap, and renegotiate cloud spend |
| Sales efficiency | Shows payback period on CAC and validates pricing | Tighten ideal customer profile and bundle annual plans with onboarding |
How to Improve Your Score
Boost retention, optimize pricing, and streamline operations to increase both growth and profitability. Even a few points improvement can raise your valuation multiple. Pair leading indicators (pipeline velocity, activation rates) with lagging indicators (LTV, net revenue retention) to prioritize the fastest lifts.
Rule of 40 Scenarios to Model
Use these sample playbooks to stress test your fundraising or exit narrative.
- Efficiency sprint: Freeze headcount for one quarter, automate support workflows, and target a 5-point margin lift without slowing net new ARR.
- Premiumization: Add usage-based add-ons and price localization to unlock 10% ARPU expansion while holding churn steady.
- Retention-first: Launch a customer health score, re-engagement emails, and quarterly business reviews to move gross churn below 3% monthly.
Check Your Valuation
Use our free valuation calculator, then unlock scenario modeling through our premium upgrade to see how Rule of 40 shifts translate into enterprise value.
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