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Rule of 40 Performance

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The Rule of 40 is a Company Health Metric that measures the trade-off between profit and growth. It suggests that Investors will only invest in companies with a combined Revenue Growth Percentage + EBITDA margin percentage above 40%.

Example of Rule of 40 for a SaaS-based Business:

Rule of 40 Performance

“One metric for investing in any growth stage company”

  • Year on Year Revenue Growth Rate= ($30 million- $25 million)/ $25 million= 20%
  • March 2022 EBITDA= $7 million
  • 2022 EBITDA Margin %= EBITDA/ Total Revenue= $7m / $30m= 23%

Rule of 40 = Revenue Growth %+ EBITDA Margin%= 20%+23%= 43%> 40%

If the number is:

Below 40% – if the company is in the early start-up stage, nothing to worry about. But if the company is in the growth stage, the Founder needs to take the matter more seriously

Exact 40% – Hitting the 40% mark means the company is eligible to be attractive as a business

Above 40% – Anything above 40%- 45% means the company is a profitable and growing company. However, they need to make sure that there is a proper balance between profit and growth otherwise this might be a fluke or short-term success.

A good time to start measuring Rule of 40 is:

  • When the company reaches $1 million MRR.
  • They have clearly separated and functioning departments like customer care, resources, CSM, R&D, distribution, and marketing.
  • The main focus should be on Gross Margins, Operational Productivity, Sales Growth, EBITDA, etc.

Credits: Fazlur Shah


Disclaimer: All content is only for technology education & knowledge sharing purpose, from mentioned sources. There is no endorsement of any products or service. The names and logos of third party products and companies shown and used in the materials are the property of their respective owners and may also be trademarks.
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