The Rule of 40 Premium

What this report finds

The Rule of 40 is the most cited shorthand in software valuation: a company whose revenue growth rate plus its profit margin clears 40 is considered healthy, and one that falls short is not.1 It is a useful discipline. It is also, as a guide to what a company is worth, badly incomplete, because the price the market pays for clearing the bar is not a constant. It depends almost entirely on what the company is called.

Before the rule can be useful, it has to be understood for what it is: a single number that compresses two of a company’s most important traits into one, and in doing so throws away most of what determines value.

Each vertical values software on its own scale. The four benchmarks below establish where each market clears today and how quality moves the number inside it. Read together, they make the cross-vertical premium in Part III impossible to miss.

With each vertical’s scale established, the cross-cut becomes arithmetic. Take a company sitting exactly at the Rule of 40, the same quality by the standard measure, and ask what it is worth in each market. The answer is the premium this report set out to size.

A benchmark is a photograph of a market in motion. The relationships in this report are stable in structure but shifting in magnitude, and a seller timing a process needs to know which way each base is trending.

If two companies post the same Rule of 40 and trade at multiples five times apart, the difference is not in the score. It is in four things the score cannot see. Each one moves the base multiple, and together they explain the dispersion in Exhibit 1.

Windsor Drake’s research desk compiled this report from transaction data, public filings, and the firm’s sell-side advisory work in software, fintech, AI, and cybersecurity. It is intended to inform founders, owners, and acquirers evaluating a transaction, and does not constitute investment advice.