Rule of 40

The Rule of 40 for SaaS companies is a metric used by venture capitalists to evaluate the performance and potential of a SaaS startup. It does NOT work all that well for super early-stage companies, and is more of a growth stage metric.

How to calculate the Rule of 40

Calculating the Rule of 40 is done by adding the company’s annual growth rate to its profit margin (expressed as a percentage) - note that most VCs only use recurring revenue growth in the calculation, ignoring non-recurring revenue or one time earnings. The goal is to have a number OVER 40.

The thesis behind the Rule of 40

The idea behind the rule is that a company’s growth and profitability should be in balance, and a company that scores above 40 is considered to be in a strong position. Venture capitalists use this rule as a way to assess a SaaS company’s potential for scaling and profitability, and it is considered as a quick and simple way to measure the health of a startup. This metric is really a “back-of-the-envelope” metric, or a “heuristic” tool, which can be used as a thumb-rule for evaluating the potential of a SaaS startup.

This metric works well for companies that are public - or for very late stage SaaS startups. However, early on in a company’s life, it is very common to have a much more negative net income. Early-stage companies tend to spend a lot on building product and getting to and staying in a sustainable product-market fit position. 

So founders should not obsess over this metric early on. Other metrics, like burn multiple and overall ARR growth (and gross profit) matter much more at the earliest stages.

Rule of 40 formula

The formula is simple (hence the appeal):

Annual recurring revenue growth rate (expressed as a %) + Net Income Margin (as a %) = Rule of 40

Over 40 = GREAT! 

Under 40 = Not growing fast enough to justify burn

Example calculations

Here are a few, made-up examples of SaaS company metrics and the resulting Rule of 40 calculations:

Example 1:

A SaaS company has a net income margin of -20% and a growth rate of 60%. When these figures are added together, the company’s Rule of 40 calculation is 40%. This indicates that the company has a balance of growth and profitability, and the rule of 40 result is right on the bubble of being “acceptable,” at least according to the theory behind this metric.

Example 2:

A SaaS company has a net income margin of -30% and a growth rate of 80%. When these figures are added together, the company’s Rule of 40 calculation is 50%. Therefore, with a strong growth rate, the company may still be considered a viable investment opportunity by venture capitalists, as long as the company can demonstrate the potential to reach positive net income margins in the future.

Example 3:

A SaaS company has a net income margin of -40% and a growth rate of 40%. When these figures are added together, the company’s Rule of 40 calculation is 0%. This startup may be considered a weak investment opportunity by venture capitalists.

It’s important to note that these are examples and the actual numbers will vary depending on the company’s current stage and industry. The Rule of 40 should not be taken as a definitive metric and should be used in conjunction with other financial and operational metrics to evaluate the performance and potential of a SaaS startup.

Why the metric sort of makes sense

Most early-stage SaaS startups operate at a negative net income margin, meaning that they are losing money. This is not surprising - these startups are investing heavily in sales and marketing efforts to acquire new customers and grow their revenue, and are still doing a high percentage of R&D vs their revenue. And if one of these startups is growing fast enough, then it is more “OK” to be losing a lot of money. 

Of course, the economic landscape changed rapidly in 2022, and many VCs were not as enamored at the “growth at all costs” mentality that they had pushed in 2021. SaaS founders will need to think beyond the Rule of 40 when evaluating their companies, focusing on quality of customers, retention, and (drum roll) - cash management and responsible burn rate.

We think more founders (and VCs) will be focusing on burn multiples, and other measures of SaaS performance in the near term. 


We are the experts at helping seed/VC-backed Delaware C-Corps with their accounting and finances!

Talk to an experienced accountant, not a generic sales person

 Kruze Consulting
Alex Janeck
 Kruze Consulting
Edith Silva
 Kruze Consulting
Randy Hall
Viz AI

$250M+ VC Funding Raised

"I had a great experience working with Kruze Consulting when we raised Series A. They know what VCs need to see, and how to present a startup’s books and finances. If you are going to raise venture capital, you need experts like Kruze."
Chris Mansi

Chris Mansi


Startup Venture Capital Assistance

With former venture capitalists on staff, our team is here to help you navigate the fundraising process and manage your board of directors

 Kruze Consulting
Scott Orn
COO | Former VC
 Kruze Consulting
Healy Jones
VP FP&A | Former VC

Scale Remote Operations & Team

"Kruze has supported us above and beyond basic accounting needs by ensuring we have everything we need to expand and support our team wherever they may be located"
Zack Fisch

Zack Fisch

Head of Operations & Legal

Clients who have worked with Kruze have collectively raised over $15 billion in VC funding.

We set startups up for fundrising success, and know how to work with the top VCs.

 Kruze Consulting
Vanessa Kruze, CPA
Founder & CEO
Kruze Logo

Experienced team helping you

Our account management team is staffed by CPAs and accountants who have, on average, 11 years of experience.

 Kruze Consulting
Bill Hollowsky, CPA
VP of Accounting Services
 Kruze Consulting
Claudine Vantomme, CPA
 Kruze Consulting
Morgan Avery
SUT/R&D Sr. Tax Accountant
 Kruze Consulting
Beth Bassler
Controller, CPA
Protara Therapeutics

Grew from a 2-person startup to a NASDAQ listed public company.

"The Kruze team helped us grow from a 2-person startup to a NASDAQ listed public company in 2 years. We wouldn’t have gotten public without Kruze’s support. Anyone thinking of launching a startup should make Vanessa their first call!"
Jesse Shefferman

Jesse Shefferman


Kruze Logo

Get in Touch

Please help us connect with you

How can we reach you?

Our first response is typically via email, so please check your inbox.

Help us have a productive first consultation by providing some additional information.

What year was your startup incorporated?

What is your stage of funding?

(pick up from the list)

Approximately how much funding have you raised?

(please enter a dollar value such as 5000000)

Help us understand what you are looking for:

(Optional, click the ones you need)

Anything additional that you’d like to share?

Optional - if you’d like to share anything else to help us prepare for our consultation, please let us know. We are also happy to sign an NDA, just let us know.

Important Tax Dates for Startups

  Talk to a leading startup CPA