A benchmark for software and technology company health: the sum of the revenue growth rate and the profit margin (FCF or EBITDA) should exceed 40%.
Deeper Explanation
The Rule of 40 balances growth and profitability by acknowledging that high-growth businesses may sacrifice near-term profit for market capture — but there should be a clear economic trade-off. A business growing at 50% with a -15% FCF margin scores 35 (below threshold) despite strong growth; it is spending more than its growth warrants. A business growing at 20% with a 25% FCF margin scores 45 (above threshold) — efficient and healthy. The rule is particularly useful for benchmarking maturing growth businesses: as revenue growth inevitably decelerates, profitability must accelerate to maintain a score above 40. Businesses that score below 40 at sub-20% growth are neither growing fast nor profitable — the most challenged category.
Continue Learning
Go deeper into the Growth school — frameworks, case studies, and decision systems.