What is the Rule of 40?
The Rule of 40 is a financial performance metric that measures a SaaS company's revenue growth and profitability. It's calculated by adding the company's Revenue Growth % to its EBITDA (earnings before interest, taxes, depreciation, and amortization) Margin. The result should be at least 40% to indicate a healthy and sustainable business model.
Why the Rule of 40 Is Important
The Rule of 40 provides a comprehensive picture of a SaaS company's financial health. It takes into account both revenue growth and profitability - two critical factors for any business. A high Rule of 40 score indicates that a company is on a path to sustainable growth and profitability, while a low score suggests that the company may need to make adjustments to its business model.
Investors and stakeholders often use the Rule of 40 as a quick and simple way to evaluate SaaS companies. A company with a high Rule of 40 score is more likely to attract investment and support from stakeholders. On the other hand, a low score could make it difficult to secure funding or interest from potential buyers or investors.
How to Calculate the Rule of 40
To calculate the Rule of 40, you need to know the company's revenue growth rate and operating margin. Here's the formula:
Rule of 40 = Revenue Growth Rate + Operating Margin
For example, if a company has a Revenue Growth Rate of 20% and an Operating margin of 30%, the Rule of 40 would be 50% (20% + 30% = 50%). As indicated by the name, a company should target a Rule of 40 result greater than 40%.