Metrics and go-to-market
Rule of 40
Revenue growth percent plus profit margin percent. Declare which profit metric you use. Necessary, not sufficient.
The Rule of 40 is a late-stage and public-SaaS heuristic, popularized by Brad Feld and widely used in public cloud comps: growth and profit should add up to at least 40. It is necessary-but-not-sufficient theater without cash efficiency. A company can "hit 40" with 80% growth and a −40% free-cash-flow margin while burn multiple is 3×.
Concept
Growth % is usually year-over-year ARR or revenue growth. Profit is variously EBITDA margin, operating margin or FCF margin — say which. Early-stage companies "failing" Rule of 40 with −60% FCF and +100% growth can still be healthy venture math. An $80M ARR company with the same margins is not.
Walking through the sum
Rule of 40 = Revenue growth % + Profit margin %Target: sum 40 or above. Examples that all "hit" 40:
- 80% growth, −40% FCF margin
- 40% growth, 0% margin
- 15% growth, 25% FCF margin
Company grows ARR 55% YoY with −10% FCF margin → Rule of 40 = 45 (passes). Peer grows 25% with +5% FCF → 30 (fails the heuristic). In a tight market the second company may still be preferred if the first's burn multiple is 3×.
Bessemer and others later pushed Rule of X variants that weight growth more heavily (growth × 2 or × 3 + margin) because compounding growth is worth more than static margin. Useful in late-stage comps. Early on, burn multiple usually cuts sharper.
A $3M ARR company "failing" Rule of 40 with −60% FCF and +100% growth can be healthy. Stage-adjust the story. Be ready to reconcile "we're Rule of 40" with "our burn multiple is 2.5×" — both can be true if growth is high and cash burn is still large relative to incremental ARR.
Common mistakes
- Not saying which profit metric. EBITDA, operating and FCF are different numbers.
- Treating 40 as a law at $3M ARR. Stage-adjust.
- Stopping at the sum. Pair it with burn multiple and retention.
Check yourself
55% growth, −10% FCF margin. Rule of 40?
45. It passes the heuristic.
Why can a pass still be a bad story?
If burn multiple is 3×, you paid dearly for the growth. The sum hid the cash cost.
Key takeaways
- Rule of 40 = growth % + profit margin %. Declare the profit metric.
- It is a late-stage heuristic, not an early-stage law.
- Weight-of-growth variants (Rule of X) exist because compounding is valuable.
- Never read it without burn multiple.
Further learning
Next, T2D3 and the tradeoffs.