Rule of 40
CRM & RetentionAlso: The 40% Rule · Rule of Forty
Quick definition
The Rule of 40 is a benchmark used mostly in software as a service (SaaS) businesses. It says a healthy company's revenue growth rate percentage plus its profit margin percentage should add up to 40 or more. A company can lean heavily on either side of the equation.
A score of 40 or above is the commonly cited healthy threshold. Check which side of the equation is carrying the score before treating it as good news.
How it varies across Australia
Early-stage Australian SaaS businesses usually clear the Rule of 40 through growth rate alone, often running at a loss. As businesses mature and funding gets harder to raise, the mix shifts toward profit margin carrying more of the score. Investors reading the combined number without checking the mix miss the real story.
See growth and margin benchmarks across Australian SaaS →What it actually means
The Rule of 40 is a shorthand investors use to sanity-check a SaaS business without reading the full financials. Add your revenue growth rate to your profit margin. Clear 40 and you're considered healthy. Fall short and questions start.
The appeal is that it treats growth and profit as interchangeable. A business growing at 60% with a negative 20% margin scores the same as one growing at 15% with a 25% margin. Both pass. Neither passing tells you which business you'd rather own.
This is where the metric gets misused. A founder chasing the number can cut marketing spend, slow hiring and improve margin just enough to hit 40, while growth collapses underneath. The score looks fine. The business is stalling.
The Rule of 40 pairs best with churn rate, customer acquisition cost (CAC) and monthly recurring revenue (MRR) trend, not on its own. A high score built on low churn and efficient CAC is a different company to one built on discounting and unsustainable growth spend. Read the components before you read the total.
The Rule of 40 doesn't care how you get to 40. That's exactly why boards love it and why it hides more than it reveals.
How to calculate it
Rule of 40 score = Revenue growth rate percent + Profit margin percent
Worked example. A SaaS business grew revenue 35% year on year and posted a profit margin of 10%. Rule of 40 score = 35 + 10 = 45. It clears the threshold, weighted mostly toward growth rather than profitability.
The Australian context
Australian SaaS businesses raising locally tend to face more pressure toward the profit margin side of the equation than their US counterparts, since local investors have historically funded growth less aggressively. A business that would happily run at negative margin to chase growth in a Silicon Valley round often gets pushed toward earlier profitability in an Australian raise. That changes which side of the Rule of 40 a founder optimises first, and it's worth knowing which game your investors are actually playing before you chase the number.
Where people get this wrong
Related terms
Common questions
Is the Rule of 40 only for SaaS businesses?
It originated in and is most commonly applied to software as a service (SaaS) businesses because their growth and margin profiles are comparable across companies. It's used less often outside SaaS because profit margin definitions vary too much between industries to make the comparison meaningful.
What counts as profit margin in the Rule of 40?
Most commonly it's EBITDA margin or free cash flow margin, though some investors use operating margin. There's no single locked definition, which is one of the metric's weaknesses. Always check which margin definition is being used before comparing scores between companies.
Can a company score below 40 and still be healthy?
Yes. A business investing heavily in a new market, rebuilding its product, or in a temporary margin dip can score below 40 and still be on a sound path. The Rule of 40 is a screening heuristic, not a definitive verdict.
How does churn rate affect the Rule of 40?
High churn rate quietly drags down both sides of the equation over time. It slows net revenue growth and forces heavier acquisition spend to replace lost customers, which erodes profit margin. A business with strong churn rate control needs less growth or margin to hit the same score.
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About New Rebellion
New Rebellion is a marketing intelligence consultancy. We build tools, score Australian businesses on how their marketing actually performs, and publish Debrief every day. This dictionary is part of how we work in the open.
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