What is the Rule of 40?

Measures the growth and profitability of a subscription business.  Across companies of all sizes, a result of 40% or more is positive and indicates strong performance.

How is Rule of 40 calculated?

To calculate the Rule of 40, simply add the company’s annual revenue growth rate and its EBITDA or Operating Profit Margin. The formula is:

Rate of 40
(%)

=

Annual revenue growth rate
(%)

+

Annual EBITDA Margin
(%)

For example, if a company has an annual revenue growth rate of 20% and annual EBITDA or Operating Profit Margin of 20%, the company’s Rule of 40 would be 40 (20 + 20). This would be considered a good result.

How is Rule of 40 used by SAAS companies?

SaaS companies often use the Rule of 40 as a benchmark for their financial performance and as a way to compare their performance to other companies in the industry. Some investors and analysts also use the Rule of 40 as a factor in valuing SaaS companies.

How is Recurring Revenue considered in the Rule of 40 calculation?

Finance teams and CFO often question whether revenue growth rate should be calculated as either recurring revenue or total revenue growth. The choice can be complex but ultimately comes down to the importance of non-recurring or one-off revenue. If it is a small percentage of the total, it is typically excluded. If it is a core part of the offering, it is included.

Even with this advice, if you are unsure, just track Rule of 40 using both definitions. Monitoring these over time frequently leads to additional insights, and clarify which is best.

What is a good result?

With Rule of 40, the higher the number, the more favorable the result. A ‘Rule of 40’ result of 40 or higher is generally considered healthy. This being said, there is huge variability in top quartile results by company size.

What are the Rule of 40 benchmarks?

Rule of 40 benchmarks results are shown below. The horizontal axis indicates the annual revenue. The vertical axis is the Rule of 40 result.

The most astounding conclusion of the benchmarks is that the average Rule of 40 benchmark scores are consistently below 40, for companies of all sizes except $2.5 – $10M. Top quartile performance is consistently above 40.

For SaaS companies with less than $1M of ARR, median Rule of 40 scores were 22% but top quartile performance was nearly 4x this amount at 80. For SAAS companies with greater than $50M in revenue, the 2022 average score was 30% while top quartile was 38%.

Benchmarks are useful to compare performance but should be considered carefully as every company is different. This being said, the Rule of 40 has become increasingly important as a driver of how businesses are valued and compared, and the benchmarks communicate clear standards.

This benchmark data was compiled by OpenView in the largest 2022 SaaS Benchmark report which includes over 600 companies located across the globe. 

Rule of 40 Visualization Example

rule of 40 example

ScaleXP makes it easy to track Rule of 40. Data is compiled automatically from your accounting or financial system, including Xero, QuickBooks and other systems. Benchmark comparisons can be added in a click, allowing you to quickly share insights across the business. 

Related links

How ScaleXP can integrate all of your data sources

How to automate your SaaS metrics