- The Rule of 40 says a software company's revenue growth rate plus its profit margin should add up to at least 40%.
- There are many routes to 40: 40% growth at breakeven, 20% growth with a 20% margin, or slower growth with high profits.
- Few companies clear it. In a sample of 46 public SaaS companies in Q2 2026, the median score was 26 and only 15% reached 40 (Aventis).
- State which margin you use: EBITDA and free cash flow margins can give quite different scores.
The Rule of 40 is a quick test of whether a software company is balancing growth and profit well. Add its revenue growth rate to its profit margin: a total of 40% or more is considered healthy. A company growing 30% with a 10% margin scores 40; one growing 50% while losing 20% of revenue scores 30.
How to calculate it
Rule of 40 score = revenue (or ARR) growth rate % + profit margin %. Growth is usually year on year. The margin is most often EBITDA margin or free cash flow margin. Free cash flow is stricter, because it includes capital spending and the cash timing of billing. Use the same definition every period, and say which one you used.
Many routes to 40
Early-stage companies usually get there through growth; mature ones through profit. Investors care about the mix too: growth tends to be valued more highly than margin, as long as it isn't bought with losses the company can't sustain.
Few companies clear it
In Aventis Advisors' sample of 46 public SaaS companies with both metrics reported in Q2 2026, the median score was 26 and only seven companies (15%) reached 40. The median company grew revenue 11.8% with a 14.6% profit margin.
A company's journey to 40
Most companies move along the line over time: growth slows as they get bigger, so margins have to rise to keep the score up. This example company grows 50% while losing 25% of revenue in year 1 (a score of 25), and crosses 40 in year 5 with 24% growth and an 18% margin.
Why investors use it
The Rule of 40 is linked to valuation. Aventis estimated from 2025 data that each 10 extra points was associated with roughly one more turn of revenue multiple. It's a simple screen, not a full valuation: net revenue retention, gross margin and scale matter too, as we cover in our post on SaaS valuation multiples.
Make these charts with your own numbers
Plot your own growth and margin by quarter in the multi-line chart, or compare against peers in the scatter plot, and download it for your board pack.
Sources and method
The companies are illustrative. Benchmarks are from Aventis Advisors' analysis of public SaaS companies (Q2 2026 sample of 46 companies; the valuation estimate is from its 2025 data). Not investment advice.