How it's calculated
The Rule of 40 adds two numbers that usually pull against each other: how fast revenue is growing and how profitable the business is. Spending more on growth lowers margins; cutting costs slows growth. A combined score of 40% or more is the benchmark for a healthy balance.
Brad Feld popularised the rule in 2015: "your growth rate + your profit should add up to 40%", preferring EBITDA as the profit measure.Brad Feld Some public companies now report it: Blackbaud defines its Rule of 40 as non-GAAP organic revenue growth plus adjusted EBITDA margin.SEC (EDGAR) Bessemer's "Rule of X" variant multiplies growth by about two to three before adding free cash flow margin, reflecting how much more markets reward growth.Bessemer Venture Partners
The formula
Rule of 40 score = revenue growth rate (%) + profit margin (%)
- Growth: year-on-year revenue (or ARR) growth, usually over the last 12 months.
- Margin: EBITDA, free cash flow or operating margin; negative if the company loses money.
- Growth needed = 40% − margin; margin needed = 40% − growth.
Worked example
Growing revenue 25% with a 15% EBITDA margin gives a score of 40%, exactly on the line. A company growing 60% while losing 25% of revenue scores 35% and would need 65% growth at that margin to pass.
| Line | Rate |
|---|---|
| Revenue growth (year on year) | 25% |
| EBITDA margin | 15% |
| Rule of 40 score | 40% |
| Target | 40% |
Assumptions and limitations
- Pick one margin measure and keep it. EBITDA, free cash flow and operating margin can differ by many points for the same company.
- Same period for both inputs.
- Less meaningful for very early companies, whose growth from a small base can be enormous while losses are large; the burn multiple is often more useful then.