The Rule of 40 for SaaS: How Public Companies Score
Published 2026-08-02
TL;DR
score = growth_rate_percent + profit_margin_percent. 40 is the pass bar. 60+ is elite. Below 40 is the honest state of most SaaS today.
The formula
Growth rate is YoY revenue growth. Profit margin is EBITDA or free cash flow, expressed as a percentage of revenue. Add them.
Brad Feld introduced it in 2015 as a shorthand for balancing burn against growth: a company growing 100% can afford a −60% margin; a company growing 20% needs +20% margin.
Worked example
Company A: 60% YoY growth, −10% EBITDA margin. Score: 50. Passes with room.
Company B: 25% YoY growth, 15% EBITDA margin. Score: 40. Passes at the line.
Company C: 15% YoY growth, 5% EBITDA margin. Score: 20. Fails.
Try scenarios in the Rule of 40 calculator.
What margin to use
EBITDA margin: original Feld definition. Widely reported, easy to look up.
FCF margin: current investor preference. Captures capitalized software development, deferred revenue timing, and stock-based comp effects. FCF-based Rule of 40 is a harder bar.
Non-GAAP operating margin: SBC excluded. Common in SaaS earnings; makes Rule of 40 easier to clear artificially.
Pick one, stay with it, and be explicit about which you’re reporting.
When the rule breaks
Early stage. A $2M ARR company growing 200% with −100% margin scores 100. That does not make it a good business; the margin math is meaningless at that base.
Consumption pricing. Usage-based revenue is choppy. Trailing-twelve-month growth smooths it.
Post-IPO efficiency mode. A once-hyper-growth company hitting 30% growth with 20% FCF margin is a different Rule-of-40 pass than a fast-growing loss-making startup at the same score.
Public SaaS benchmarks
From Meritech’s public SaaS index (approximate, mid-2020s):
- Elite (>60): ~5% of the index. Snowflake at IPO. Datadog in peak years.
- Meets (40–60): ~25%. Cloudflare in most years.
- Below (<40): the majority. Growth compression post-2022 knocked most companies below.
The board conversation post-2022: growth from 60% to 30% is fine if margin goes from −20% to +15%. The score holds.
Common mistakes
- Mixing EBITDA growth with non-EBITDA margin.
- Using bookings growth instead of revenue growth.
- Not netting stock-based comp when the audience expects it.
- Applying it to businesses under $10M ARR.
- Comparing your score to a company with 10x your scale.
Related
- Rule of 40 Calculator
- Burn Rate Calculator — the burn side of the trade-off
- MRR / ARR Growth — the growth side
FAQ
Which margin do investors use?+
EBITDA is classic. FCF margin is the current preference because SBC and capitalized R&D can inflate EBITDA.
Does it apply below $25M ARR?+
Not meaningfully. Below scale, growth dominates and margin is usually deeply negative by choice.
What score do top public SaaS hit?+
Snowflake, Datadog, Cloudflare regularly cleared 50-60 in the growth years; the median public SaaS in 2023-24 hovered mid-30s.
Can you fake it with one-time revenue?+
Yes; large multi-year prepay bookings inflate ARR growth for a period. Normalize before scoring.
What about the Rule of 60 or 50?+
Higher-bar variants for elite companies. Same math, higher target.