The most cited shorthand in software valuation, what it measures, how to calculate it, and how acquirers actually translate it into a multiple.
The Rule of 40 adds a company’s revenue growth rate to its profit margin. If the two together reach 40 or more, the business is considered to be balancing growth and profitability in a healthy way. A company growing 30 percent with a 12 percent margin scores 42 and passes. A company growing 15 percent with a 10 percent margin scores 25 and does not.
The appeal is its simplicity. It rewards a fast-growing company that burns cash and an efficient company that grows slowly in equal measure, which makes it a quick way to compare very different software businesses on one line.
Take year-over-year revenue growth as a percentage and add a profitability margin, usually EBITDA margin or free cash flow margin. The choice of margin matters: the same company can clear the line on one measure and miss on another, so the figure should always state which margin was used. For recurring-revenue businesses, ARR growth is often used in place of reported revenue growth.
| Combined score | Read | Typical valuation effect |
|---|---|---|
| Above 60 | Strong | Premium multiple |
| 40 to 60 | Healthy | In line with market |
| Below 40 | Below the bar | Discount, unless a clear path back above the line |
These are general reads, not fixed rules. The threshold is conventional rather than precise, and a company sitting just under 40 with improving trajectory is treated very differently from one drifting down toward it.
Here is where the shorthand breaks down. Two companies can both score exactly 40 and be worth very different multiples, because acquirers do not value growth and margin the same way. A business at 30 percent growth and 10 percent margin usually attracts a higher multiple than one at 10 percent growth and 30 percent margin, even though both score 40, because growth is harder to manufacture and signals a larger future. The composition of the score, not just the score, drives the price.
Windsor Drake’s Rule of 40 Premium report quantifies this across verticals, showing how the same score is priced four different ways. For current multiples by ARR band, see our SaaS valuation multiples analysis.
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