What is the Rule of 40?

Written by Madalena Rugeroni, founder of Mazo · Updated 10 November 2026

The Rule of 40 says a healthy SaaS company's revenue growth rate plus its profit margin should add up to at least 40%. It judges whether a company balances growth and profitability: fast growth can justify losses, and slow growth needs profit to compensate.

Rule of 40 formula

Rule of 40 score = revenue growth rate (%) + profit margin (%) Healthy if the score ≥ 40%

Growth is usually year-over-year growth in ARR or revenue. For the margin, most investors use EBITDA margin or free cash flow margin. Pick one, say which, and use it consistently.

Worked example

Three fictional SaaS companies, each with €10M ARR:

A: growing 60%, EBITDA margin −15%. Score = 60 − 15 = 45. Passes.
B: growing 20%, EBITDA margin +25%. Score = 20 + 25 = 45. Passes.
C: growing 25%, EBITDA margin −10%. Score = 25 − 10 = 15. Fails: it's burning cash without growing fast enough to justify it.

Why it matters from €0 to €1M ARR

Before €1M ARR: the Rule of 40 tells you very little. Going from €100k to €300k is 200% growth, which passes regardless of margin.
What to watch instead: CAC payback, net revenue retention and months of runway.
Around €5M+ ARR: investors start using it to compare you with other SaaS companies, so learn to calculate it before you're asked.

Mazo's rule of thumb: if someone quotes the Rule of 40 at a €300k ARR company, ask what the payback period on the next euro of spend is instead. Early on, efficiency per customer matters more than a blended score.

Common Rule of 40 mistakes

Applying it to early-stage startups. High percentage growth on a small base passes automatically.
Mixing margin definitions. EBITDA and free cash flow margins can differ a lot.
Using one unusual quarter. Use trailing twelve months or year-over-year numbers.
Treating 40 as a target to optimise. It's a sanity check on balance between growth and burn.

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FAQ

How do you calculate the Rule of 40?

Add your year-over-year revenue growth rate to your profit margin, both as percentages. Most companies use EBITDA margin or free cash flow margin. A total of 40% or more is considered healthy.

Does the Rule of 40 apply to early-stage startups?

Not in a useful way. Small companies often grow 100% or more a year, so they pass regardless of how much cash they burn. It becomes meaningful at several million in ARR.

Who came up with the Rule of 40?

It was popularised in 2015 by venture capitalist Brad Feld, who wrote about it as a rule of thumb used by SaaS investors.

Who wrote this

Madalena Rugeroni built Mazo. She's an ex-Googler, a startup advisor and investor, and runs a portfolio of internet companies. Before that, as Head of Growth at Amplemarket, she scaled a B2B SaaS to $10M ARR. LinkedIn

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Further reading. The Rule of 40 was popularised by Brad Feld (Foundry) in a 2015 blog post. Mazo is not affiliated with or endorsed by him.