The Rule of 40: A Must-Know Metric for SaaS Business

In the fast-paced world of SaaS, success isn’t defined by growth alone. Some companies scale rapidly but burn through cash, while others stay profitable yet struggle to expand. So how do investors and founders know if a SaaS business is truly healthy? 

That’s where the Rule of 40 comes in, a simple yet powerful benchmark that combines two of the most important SaaS metrics—growth and profitability—into one clear indicator of performance. 

In this blog, we’ll explore what the Rule of 40 means, why it matters for SaaS valuation, when to use it, and how to calculate it with real-world context. Whether you’re building an early-stage startup or managing a mature SaaS product, understanding this metric can help you make smarter, data-driven business decisions.

What is the Rule of 40?

The Rule of 40 is a benchmark that helps SaaS companies determine if they’re growing efficiently. Originally popularized by venture capitalists, Rule of 40 is now used by SaaS leaders to determine whether their company is running efficiently and built to last.

Note:

• Revenue growth rate: The percentage increase in your company’s recurring revenue over a specific period, showing how quickly your business is expanding through new or existing customers.
• Profit margin: The percentage of revenue your company keeps as profit after covering all operating expenses, showing how efficiently you manage costs and generate sustainable earnings.

The basic idea is straightforward: your company’s revenue growth rate plus your profit margin should equal at least 40%. For example, if your SaaS company grows revenue by 25% this year and has a 15% profit margin, your Rule of 40 score is 40%, right at the benchmark for healthy performance.

Why Use the Rule of 40 in SaaS?

The Rule of 40 was specifically designed for SaaS companies, as they operate differently from traditional software businesses. While traditional businesses earn revenue upfront through one-time licenses, SaaS companies rely on recurring subscriptions, with customers paying monthly or annually over time.

This means SaaS businesses must invest significantly upfront to acquire customers, then rely on recurring revenue and long-term retention to become profitable. The Rule of 40 measures whether this unique growth model is financially sustainable.

The metric has become essential across the SaaS ecosystem, serving distinct purposes for different stakeholders:

1. For founders: Internal performance management

The Rule of 40 enables leadership teams to monitor whether their growth strategy is sustainable over time. It provides an objective measure for evaluating operational decisions, from customer acquisition investments to pricing adjustments.

By tracking this metric regularly, founders can identify when to accelerate growth spending or shift focus toward profitability. This ensures the business maintains a healthy trajectory through different stages of development.

2. For investors: Due diligence and valuation

Investors rely on the Rule of 40 as a standardized assessment tool during due diligence. A score above 40 signals a well-managed business with efficient operations. Scores above 50 indicate top-tier performance.

These benchmarks directly influence valuation multiples and investment decisions. They demonstrate a company’s ability to scale without compromising financial discipline. The metric provides investors with a quick but reliable indicator of overall business quality.

When Should You Use the Rule of 40?

The Rule of 40 applies differently depending on where your company is in its journey. Understanding these distinctions helps you use the metric effectively rather than just tracking a number.

1. Early-stage startups: Check if your growth is healthy

At this stage, your main goal is to prove that your product works and that people want it. Profit doesn’t matter yet, but efficiency does. The Rule of 40 helps you see if you’re growing healthily or just spending too much to get new users.

For example, a startup growing 70% with a -20% profit margin still scores 50. That means your growth is strong, even if you’re not profitable yet. The key is whether your spending helps you build a foundation for future growth.

Why it matters: It helps early founders stay disciplined. Instead of just chasing fast growth at any cost,  it ensures that every dollar spent contributes to meaningful, long-term progress.

2. Growth-stage companies: Balance growth and spending

Once you’ve found product-market fit, the focus shifts to scaling the business. Growth is still important, but now it needs to be smart. The Rule of 40 helps you make sure your expansion isn’t cutting into your profits or creating hidden inefficiencies.

For example, a company with 35% growth and a 10% profit margin (score: 45) is scaling well. It’s earning more without overspending to do so.

Why it matters: It helps you make smarter decisions—like reducing churn, improving pricing, or optimizing marketing—so you can grow steadily without wasting resources.

3. Mature or Public Companies: Prove you can grow steadily

For established SaaS companies, the Rule of 40 is about showing consistency and control. Investors expect reliable performance, not rapid growth at any cost.

Mature SaaS companies often grow 15–25% per year with 20–30% profit margins—scores that stay above 40. This proves that the business can grow while maintaining strong profits and stability.

Why it matters: A steady Rule of 40 score shows your company can deliver predictable results and long-term value, which boosts your reputation and earns investors’ trust. 

4. Strategic planning: Use it as a guide for big decisions

Beyond tracking performance, the Rule of 40 can guide major business decisions. It shows whether new plans, like product launches, pricing updates, or expansion, make your company stronger or weaker.

If a new initiative drops your score below 40, it could mean you’re overspending. If your margins are high but growth is slowing, it might be time to reinvest in marketing or innovation.

Why it matters: The Rule of 40 helps you find the right balance between growth and profitability. It gives leaders a clear view of when to invest more, when to save, and how to keep the business healthy in the long run.

Check this out: SaaS Pricing Page Design – Best Practices for Higher Conversion Rates

How to Calculate the Rule of 40 for SaaS

Calculating the Rule of 40 is fairly simple, but truly understanding what the number means requires context. The formula combines 2 crucial SaaS metrics, revenue growth rate and profit margin, into one snapshot of overall financial health. 

Let’s go step-by-step through the process:

Step 1: Calculate your revenue growth rate

Your revenue growth rate measures how much your company’s revenue has increased compared to the previous year.

Formula:

Example:
If your revenue grew from $5 million to $7 million, your growth rate is ((7 – 5) / 5) × 100 = 40%.

A high growth rate shows strong demand for your product and effective market execution, but if you’re spending too much to achieve it, growth alone doesn’t guarantee success.

Step 2: Calculate your profit margin

Your profit margin shows how much of your total revenue remains as profit after covering all costs, such as operations, marketing, and salaries.

Formula:

Example:
If your company earned $0.5 million in profit on $7 million in revenue, your profit margin is (0.5 / 7) × 100 = 7.1%.

Profit margins tell you how efficiently your company turns revenue into profit. While many early-stage SaaS companies have negative margins due to upfront investments, improving this ratio over time shows financial discipline.

Step 3: Combine the two numbers

Now, simply add your revenue growth rate and profit margin to calculate your Rule of 40 score.

Formula: Rule of 40 = Revenue growth rate + Profit margin

Example:
40% (growth) + 7.1% (profit margin) = 47.1%

How to interpret the result of the Rule of 40 in practice

Your Rule of 40 score reveals your company’s overall health and guides where to focus next. Here’s what different score ranges indicate:

Score of 40 or Above: Efficient & sustainable

Meaning: A score at or above 40 indicates healthy, efficient operations. Your company is growing while maintaining financial discipline, which demonstrates strong product-market fit and effective cost management.

What to do: Continue monitoring key levers (e.g., customer acquisition costs, pricing strategy, retention rates, etc) to sustain this momentum.

Score Below 40: Inefficient, needs review

Meaning: A score below 40 signals an imbalance that requires attention. Growth may be slowing, expenses rising too quickly, or profit margins declining. This isn’t necessarily a crisis, but it indicates the need for strategic adjustment.

What to do: 

• Review your resource allocation across customer acquisition, retention programs, and operational costs. 
• Identify inefficiencies and opportunities for optimization. Common improvements include reducing churn, refining pricing models, or streamlining operations. 

Read more: SaaS UX Design – Exploring Best Practices with Insights from Mavic’s Case Study

Final Thoughts

The Rule of 40 is more than a benchmark; it’s a mindset that encourages SaaS businesses to balance ambition with accountability. It reminds founders that sustainable growth comes from both scaling wisely and managing profitability. By maintaining a Rule of 40 score above 40, companies can signal to investors and teams alike that they’re building a resilient, scalable business.

As a SaaS design agency,  Lollypop Design Studio help SaaS companies translate complex business goals into intuitive user experiences. From designing data-driven dashboards to optimizing conversion journeys, our team ensures that design supports your growth and efficiency metrics.

Book a free consultation to explore how thoughtful UX can help improve your SaaS  performance and strengthen your Rule of 40 score.

Frequently Asked Questions (FAQs)

1. Should startups measure the Rule of 40?

Yes. Even if you’re not yet profitable, tracking the Rule of 40 helps you understand whether your growth is sustainable. It highlights if your spending aligns with long-term scalability rather than short-term wins.

2. What is a good SaaS company growth rate?

Healthy SaaS companies typically experience annual growth rates of between 20% and 40%. Startups in early stages might exceed this, while mature firms normally maintain steady, profitable growth.

3. How many SaaS companies exceed the Rule of 40?

Research shows that fewer than one-third of public SaaS companies consistently maintain a Rule of 40 score above 40. Those that do often achieve strong valuations and investor trust due to their balanced operations.

4. What is the difference between the Weighted Rule of 40 and the standard formula?

The Weighted Rule of 40 adjusts the formula based on company maturity. For instance, early-stage startups might emphasize growth with a 70/30 weighting, while mature companies might focus more on profitability with a 40/60 split. This allows fairer comparisons across stages of growth.