The Rule of 40 formula
The Rule of 40 says a software company's year-over-year revenue growth rate plus its profit margin should add up to at least 40 percent. This calculator takes growth from two years of revenue and margin as operating profit over this year's revenue. Scores are not always comparable, because Brad Feld measured growth in MRR and profit as EBITDA.
growth rate = (revenue this year − revenue last year) / revenue last year margin = operating profit / revenue this year score = growth rate % + margin % → pass at 40 or more
The rule exists because growth and profitability trade against each other, and judging either alone rewards the wrong things. A company burning heavily can be excellent if it grows fast enough; a slow grower can be excellent if it is genuinely profitable. Adding the two puts every company on one scale.
The rule was written up by Brad Feld in a February 2015 post: growth rate plus profit should add up to 40 percent. Feld heard it from an unnamed late stage investor, so the origin is older than the post. He measured growth as year-over-year MRR growth and profit as EBITDA; this calculator uses revenue and operating profit. The full treatment, with a worked example and the common ways companies flatter the score, is in Rule of 40: what it is, how to calculate it, and when it lies.
It is a later-stage yardstick. If you are pre-Series A, the score will either flatter you absurdly or scare you pointlessly; the ratios that actually decide things at that stage are the burn multiple and the SaaS magic number, which measure what growth costs while there is still a runway clock running.