From Startup Fortune · · 1m 40s
Rule of 40 Score Calculation for Startups
How to calculate your startup's Rule of 40 score before investors do.
In brief
How to calculate your startup's Rule of 40 score before investors do. Rule of 40 score combines revenue growth rate and profit margin to assess startup health, with 40 as a benchmark for growth-stage SaaS companies. Originally reported by Startup Fortune.
Rule of 40 Definition
Rule of 40 is revenue growth rate plus profit margin, usually EBITDA or free cash flow margin.
“Rule of 40 is just revenue growth rate plus profit margin, usually EBITDA margin or free cash flow margin”
Why Founders Misuse It
Founders often swap gross margin for EBITDA margin, inflating the score by 20 to 30 points.
“Swap EBITDA margin for gross margin and your score jumps 20 to 30 points instantly”
Bessemer's Benchmark
Bessemer Venture Partners uses 40% as a line separating efficient growth from capital-burning growth at scale.
“Bessemer Venture Partners' State of the Cloud reports treat 40% as the line separating efficient growth from capital-burning growth at scale”
HubSpot Example
HubSpot's revenue grew 20% year over year with a mid-teens non-GAAP operating margin, landing in the mid-30s on Rule of 40.
“HubSpot's revenue grew roughly 20% year over year in recent reporting periods”
Datadog Example
Datadog's revenue grew in the high 20s percent with a GAAP operating margin near break-even, showing different Rule of 40 scores based on margin choice.
“Datadog, growing revenue in the high 20s percent with a GAAP operating margin that's been closer to break-even”
When It Matters
Rule of 40 becomes critical at Series B and beyond, when growth percentages are meaningful and investors expect a growth-profitability tradeoff.
“Where it starts to matter is Series B and beyond, when a company has enough revenue that growth percentages are meaningful”
Common Mistakes
Founders mix time periods, use net revenue retention instead of growth rate, or present Rule of 40 as the only metric that matters.
“Three mistakes show up constantly in board decks: mixing time periods, using net revenue retention, or presenting Rule of 40 as the only number that matters”
Slack's Case
Slack grew revenue above 50% annually with deeply negative operating margins before its 2019 direct listing, passing Rule of 40.
“Slack, before its 2019 direct listing, grew revenue well above 50% annually while running deeply negative operating margins”
How to Calculate
Add your revenue growth rate to your profit margin, using EBITDA or free cash flow margin for the profitability leg.
“Add your revenue growth rate to your profit margin. That's the whole formula”
Investor Test
Investors test whether founders understand the Rule of 40 score and can explain which lever moved it.
“Frankly, the founders who handle this best are the ones who show up to the board meeting with the Rule of 40 number on one line and then immediately explain which lever moved it and why”
The takeaway
Rule of 40 score combines revenue growth rate and profit margin to assess startup health, with 40 as a benchmark for growth-stage SaaS companies.
