The Rule of 40: A Refresher

High growth startups are not expected to be profitable, but in the wake of 2021’s excesses, startups are now expected to manage the bottom line more carefully. What does that mean? And how much burn is OK?

A useful metric is The Rule of 40, a concept popularized in 2015 by Brad Feld. In short, The Rule of 40 states that for healthy SaaS companies the growth rate + profit rate should be at least 40%. Specifically:

The Rule of 40 = Year-over-Year Revenue % + EBITDA margin %

So if a company is growing 50% YoY, EBITDA margin for that same period should be better than -10%. A company growing 100% YoY can support a -60% EBITDA margin. Intuitively, the faster you’re growing the more burn you can justify. The Rule of 40 does a nice job boiling two numbers often at odds with each other into a singular metric.

This metric is relevant for mature companies, Series A and beyond, and is used for marketplace businesses in addition to SaaS businesses. As companies and boards move into 2024 budget planning, this is a helfpul metric to keep in mind.