Software and internet platforms
Rule of 40
A software company's growth rate plus its profit margin should add up to at least 40 percent.
Last reviewedWhat does Rule of 40 mean?
The rule of 40 is a quick health check for software companies: revenue growth rate plus profit margin should be at least 40 percent. The profit measure varies; many investors use free cash flow margin, others EBITDA margin. Example: a company growing 30 percent with a 12 percent free cash flow margin scores 42 and passes, while one growing 50 percent with a margin of minus 20 percent scores 30 and fails. It lets investors compare a fast-growing, loss-making company with a slower, profitable one. McKinsey research has found that only a minority of software companies reach it. It is a rule of thumb, not a law.
Where does it come up in case interview prep?
- How software and SaaS companies workLesson in Software and SaaS
- SaaS unit economics: ARR bridge, NRR, CAC payback, and rule of 40Lesson in Software and SaaS
- Software and SaaS: players, trends, regulation, and how to crack the casesLesson in Software and SaaS
- Cybersecurity: players, trends, rules and casesLesson in Cybersecurity
Related terms
- Annual recurring revenue (ARR)The yearly value of all active subscription contracts at a point in time.
- Free cash flowCash from operations minus capital expenditure.
- EBITDAEarnings before interest, taxes, depreciation and amortization.
- Net revenue retention (NRR)How much recurring revenue a group of existing customers brings in a year later.
- CAC payback periodHow many months of gross profit it takes to earn back the cost of winning a customer.
- Gross merchandise value (GMV)The total value of goods or services sold through a platform.
- CPM (cost per thousand impressions)The price an advertiser pays for 1,000 views of an ad.
- CPC (cost per click)The price an advertiser pays each time someone clicks an ad.