Quick answer
The Rule of 40 is a benchmark for software companies: revenue growth rate plus profit margin, both as percentages, should add up to 40% or more, showing a healthy balance between growing and making money.
Formula: Rule of 40 score = revenue growth rate (%) + profit margin (%)
What is the Rule of 40?
The Rule of 40 is a quick health check for software and subscription businesses:
Rule of 40 score = revenue growth rate (%) + profit margin (%)
A score of 40 or more suggests the company balances growth and profitability well. The idea spread in 2015 through a blog post by investor Brad Feld, who credited it to growth investors; it is now a common line in SaaS board decks and public-company comparisons.
The point is the trade-off. A company can burn cash to grow fast, or grow slowly and be very profitable. The rule says either is fine as long as the sum stays high.
Worked examples
| Company (sample) | Revenue growth | Profit margin | Score |
|---|---|---|---|
| A, fast-growing | 60% | −25% | 35 |
| B, balanced | 25% | 20% | 45 |
| C, mature | 10% | 35% | 45 |
Company A grows fastest but falls short, because its losses are deep. B and C pass by different routes. A board looking at A would ask whether the spending is buying durable growth, for example by checking CAC payback and retention.
Which inputs to use
- Growth rate: year-over-year growth of revenue, or of annual recurring revenue for subscription companies. Use year over year, not one strong month annualised.
- Profit margin: EBITDA margin is the most common; free cash flow margin is stricter because it includes capitalised costs and timing. Choose one and keep it.
- Period: trailing twelve months smooths seasonality better than a single quarter.
How to read it by stage
| Stage | What usually drives the score |
|---|---|
| Early (under about $5M ARR) | Growth dominates; the score is noisy and not very meaningful |
| Scaling | Growth slows; margins must start to climb to stay near 40 |
| Mature | Margin carries most of the score |
Limits
- It ignores how growth is bought. Two companies at 40 can have very different retention.
- It mixes a rate of change with a level, so a one-off price increase or cost cut moves it sharply.
- Margin definitions differ between companies, which makes cross-company comparison rough.
The product metrics behind each side
Growth comes from new customers and expansion, minus churn, so net revenue retention, gross revenue retention and activation rate feed it directly. Margin improves with lower acquisition cost per customer (cost per acquisition) and channels that convert without paid spend.
TapCub does not read your accounting system, so it cannot compute the score itself. It covers the growth-side inputs: purchases and signups sent as server events, revenue on goals, channel attribution, funnels and retention.
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Data Engineer
Writes about event design, data quality, and collection workflows, with verifiable implementation methods for reliable analytics.