Rule of 40
The Rule of 40 is a heuristic for software businesses: add the revenue growth rate (percent) to a profitability margin (percent), and the sum is the score. The convention holds that a healthy company should reach roughly 40, trading growth against profit — fast growth can justify thin margins and vice versa. It is an industry rule of thumb, not an accounting standard, and the choice of margin varies.
What this means
Rule of 40 score = revenue growth rate (%) + profitability margin (%). For example, a company growing 30% with a 10% margin scores 40; one growing 50% at −10% also scores 40. The idea is that growth and profitability are substitutable up to a point: a company can spend margin to grow faster, or slow growth to bank profit, and still land in the same band.
Why it is a convention, not a law
The Rule of 40 is a widely cited heuristic from software investing, not a defined accounting metric. The number 40 is conventional, and the second term is ambiguous — practitioners use different profitability measures (operating margin, free-cash-flow margin, EBITDA margin), which change the score for the same company. It also breaks down at extremes: a barely-growing, highly profitable mature business and a hyper-growth unprofitable one can share a score that means very different things. Use it as a directional balance check alongside the underlying growth and margin figures.
This page is educational and not financial advice.
- Score = growth rate % + profitability margin %
- The '40' threshold is a convention, not a standard
- Margin definition (FCF, EBITDA, operating) changes the score
How it appears in analytics and logs
A Rule of 40 score near or above 40 suggests the growth/profit trade-off is in a commonly cited healthy band; a low score means the company is neither growing fast nor profitable. It is a balance check, not a target to optimize directly.
Diagnostic use case
Summarize the growth-versus-profitability balance of a software business in one score, to compare companies pursuing different mixes of the two.
What WebmasterID can help detect
WebmasterID measures acquisition and conversion signals first-party that feed the growth side of the equation, without third-party identifiers.
Common mistakes
- Treating 40 as an exact, official threshold.
- Not stating which profitability margin is used.
- Applying the rule to non-software or pre-revenue companies.
Privacy and accuracy notes
The Rule of 40 combines aggregate financial rates and uses no personal data. This page is educational and not financial advice.
Related pages
- Burn multiple
The burn multiple divides net cash burned in a period by the net new annual recurring revenue (ARR) added in the same period. It answers: how many dollars of cash did the company spend to add one dollar of new recurring revenue? A lower multiple means more efficient growth. It is a startup-finance convention popularized as a capital-efficiency gauge, not an accounting standard.
- Net revenue retention (NRR)
Net revenue retention (NRR), also called net dollar retention, measures how much recurring revenue a fixed cohort of customers produces at the end of a period versus the start, counting upgrades (expansion) and subtracting downgrades (contraction) and churn — but excluding revenue from brand-new customers. Above 100% means the cohort grew on its own. It is a subscription-economics convention, and definitions vary by vendor.
- Contribution margin
Contribution margin is revenue minus the variable costs of producing it — the money each unit or order contributes toward fixed costs and profit. It can be expressed per unit, in total, or as a ratio of revenue. Because it isolates variable costs, it differs from gross margin (which uses cost of goods sold) and is the figure used to reason about scaling, pricing, and break-even.
- Web analytics
Feed the growth side with first-party signals.
Sources and verification notes
- U.S. SEC — investor guide to financial statementsBackground on growth and margin concepts; the Rule of 40 is an investing heuristic, not an official standard.
Last reviewed 2026-06-24. Facts are checked against primary/official sources where available; uncertain specifics are marked “Data not yet verified” rather than guessed.