For SaaS founders, mastering the Rule of 40 is no longer optional—it’s essential. Focusing solely on growth or profitability won't be enough as the market grows more competitive and investor expectations rise.
The Rule of 40 combines a company’s revenue growth and profitability into a straightforward calculation: the total of your growth rate and EBITDA profit margin should equal or exceed 40%. This rule helps SaaS companies balance rapid expansion and financial stability, ensuring long-term sustainability.
In this article, we’ll break down the Rule of 40, explain how to calculate it, and explore why it’s one of the most important metrics you need to track in 2025.
The Rule of 40 is an important performance benchmark for SaaS companies. While it’s a relatively simple concept, it is highly effective in evaluating a company’s balance between growth and profitability.
The Rule of 40 originated in the SaaS industry as a guideline to help investors and founders assess the long-term sustainability of a SaaS business model. Venture capitalist Brad Feld popularized the concept in 2015. As SaaS companies tried to understand how to prioritize both recurring revenue and long-term customer retention, the Rule of 40 emerged as a balancing act between growth and profitability.
The Rule of 40 simply states:
Revenue Growth Rate (%) + EBITDA Margin (Profit Margin) (%) ≥ 40%
To meet the Rule of 40, a company’s total revenue growth rate and profit margin must be 40% or higher. If a SaaS company is growing rapidly, it may operate at a loss and still be considered an attractive proposition (i.e. revenue growth of 100% and EBITDA margins of -50%). Alternatively, a company with slower growth may need to focus on improving profitability to hit the Rule of 40.
The Rule of 40 provides the most value for mature SaaS companies with established business models. Early-stage startups often prioritize aggressive growth over immediate profitability, making this metric less applicable since the company is only focusing on half of the equation. Companies typically find the Rule of 40 most meaningful:
To apply the Rule of 40, you need to calculate two key metrics: revenue growth and EBITDA margin.
Revenue growth rate measures how much a company’s revenue has increased compared to the previous period, typically annually. For SaaS companies, the revenue growth rate is often measured using Annual Recurring Revenue (ARR). To calculate ARR:
Monthly Recurring Revenue (MRR) = Total Active Customer Accounts × Average Revenue Per Account (ARPA)
ARR = MRR × 12 months
Once you have ARR for both the current and previous periods, calculate the revenue growth rate:
Revenue Growth Rate = (Current Year ARR – Prior Year ARR) ÷ Prior Year ARR
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) measures profitability by excluding non-operational expenses and focusing on core operations. In other words, it shows how efficiently a company turns revenue into profit. The formula is:
EBITDA Margin (%) = EBITDA ÷ Revenue
Now, add the revenue growth rate and EBITDA margin:
Revenue Growth Rate (%) + EBITDA Margin (Profit Margin) (%) ≥ 40%
Let’s consider a hypothetical SaaS company, TechSolutions, with the following financial data for the current year:
To calculate TechSolutions’ revenue growth rate:
Revenue Growth Rate = ($20 million – $18 million) ÷ $18 million = 11.11%
To calculate TechSolutions’ EBITDA margin:
EBITDA Margin = $2 million ÷ $22 million = 9.09%
Now, apply the Rule of 40:
Rule of 40 = 11.11% + 9.09% = 20.2%
TechSolutions falls short of the Rule of 40, as its combined growth rate and EBITDA margin total 20.2%. The company might still be considered strong: after all, it’s growing and turning a profit. However, to meet the Rule of 40 and be more attractive to investors, the company needs to either accelerate revenue growth or improve profitability.
In the early stages of growth, companies often prioritize expanding their customer base and increasing revenue, which typically leads to negative or low profit margins. In contrast, focusing on profitability usually means slowing down growth to optimize efficiency, limiting the company’s ability to scale rapidly.
Tech companies generally fall into three groups that influence how the Rule of 40 is applied:
When you meet or exceed the Rule of 40, you can demonstrate your company’s ability to scale responsibly and maintain financial health. But what exactly does that mean?
Here are the three reasons why the Rule of 40 is important:
The Rule of 40 is a valuable benchmark for assessing the balance between revenue growth and profitability in SaaS companies. Combining these two factors gives you a snapshot of your company’s financial health and scalability.
However, it’s important to remember that the Rule of 40 is just one metric among many that SaaS companies should track. How you use this metric depends on your company’s growth stage and overall strategy.
At G-Squared Partners, we have a team of expert SaaS accountants ready to handle your financials. Whether focusing on growth, profitability, or finding the right balance between the two, we can help you select and track the right metrics to guide your strategy and achieve long-term success.
Schedule a call with G-Squared Partners today to learn how we can help you build a robust financial strategy.