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A Summary of

A Quick Primer on the Rule of 40

by
Sam Baker
Scale Venture Partners
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Rule of 40

  • Better used for mature SaaS companies
  • Can be used to compare viability of two different SaaS companies
  • A company's revenue growth rate plus profitability margin should be equal to or greater than 40%
  • Measure of the balance between growth and profitability, and by extension, the sustainability of the business more broadly

Key Driver: Growth Rate

  • Year-over-year growth % based on GAAP revenue
  • Can use top line growth but makes it hard to compare companies

Key Driver: Profitability Margin

  • You can use multiple metrics for profitability (e.g., unlevered cash flow, cash from ops, net change in cash)
  • EBITDA excluding stock-based compensation (SBC) costs will be used to compare companies
  • Depending on which profitability margin metric you use, your analysis will change. What is most important is understanding how.

Rule of 40 and the Market

  • The market over the past 10 years has a median of 41% so this proves to be a good proxy for growth vs. profitability
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