C4 · Economics & metrics · heuristic

Rule of 40

Also: Rule of 40

Definition. The Rule of 40 is a heuristic for balancing SaaS growth and profitability: ARR growth rate (%) plus EBITDA margin (%) should equal or exceed 40. Scores above 40 indicate a healthy balance. Scores above 60 characterize best-in-class public SaaS companies per Bessemer 2024. Below 40, the company is either growing too slowly or burning too much relative to growth.

established heuristic — not a law; accuracy degrades at ARR < $10M and ARR > $1B Last updated 2026-06-18 Source: Bessemer Venture Partners State of the Cloud 2024; Brad Feld / Fred Wilson (original popularization ~2015); McKinsey SaaS benchmarks 2024

Formula

Rule of 40 heuristic

R_{40} = growth % \frac{A R R _{t} - A R R _{t - 12}}{A R R _{t - 12}} \times 100 + margin % \frac{E B I T D A}{Revenue} \times 100

Plain English: Rule of 40 Score = ARR Growth Rate % + EBITDA Margin %

Notation: R40 = ((ARR_t - ARR_{t-12}) / ARR_{t-12} × 100) + (EBITDA / Revenue × 100)

Benchmark by stage

Source: Bessemer Venture Partners State of the Cloud 2024; Brad Feld / Fred Wilson (original popularization ~2015); McKinsey SaaS benchmarks 2024

Stage	Rule of 40	Notes
Below threshold	< 40	Growth and/or profitability insufficient relative to capital deployed
Good	40–60	Meets the Rule of 40; typical for healthy mid-growth public SaaS
Best-in-class (Bessemer 2024)	> 60	Top quartile public SaaS; Bessemer Cloud 100 median ~55 in 2024
Exceptional	> 80	Very rare; typically driven by near-monopoly market position or extreme efficiency

Naive vs corrected

Version	Formula
Naive	Revenue growth rate + EBITDA margin — using GAAP revenue growth rather than ARR growth conflates deferred revenue timing with recurring revenue momentum
Corrected	Use ARR growth rate (not revenue growth) and Free Cash Flow margin (not EBITDA) for capital-intensive businesses where stock-based compensation or D&A are significant. Bessemer recommends FCF margin as the profitability input for more accurate capital efficiency measurement.

Common errors

Using revenue growth instead of ARR growth — diverges significantly in high-growth periods due to deferred revenue
Using non-GAAP operating margin rather than EBITDA or FCF — creates comparability issues across companies
Applying Rule of 40 to early-stage companies (< $5M ARR) — the rule is calibrated for scale-stage and public SaaS
Ignoring that the rule is symmetric: 80% growth + (-40%) EBITDA = 40, but the sustainability differs from 20% growth + 20% EBITDA = 40
Not considering Rule of X as a growth-weighted alternative in high-growth regimes (see rule-of-x)

Where this sits

Part of the Economics & metrics (C4) cluster in the GTM World Model. Related to the model's "R40 is a linear constraint on the growth-profitability tradeoff plane; Rule of X replaces this linear weighting with growth_rate × X_factor + FCF_margin to reward growth more heavily in capital-efficient environments" equation.

arr →burn multiple →rule of x →magic number →

How to cite this

@misc{shalvi_gtm_metric_rule_of_40_2026,
  author = {Singh, Shalvi},
  title  = {Rule of 40 — GTM World Model Metrics},
  year   = {2026},
  url    = {https://shalvisingh.com/gtm/metrics/rule-of-40}
}

Singh, Shalvi. "Rule of 40 — GTM World Model Metrics." shalvisingh.com, 2026. https://shalvisingh.com/gtm/metrics/rule-of-40