At the start of the year, The Wall Street Journal wrote an article calling the Rule of 40 one of the hot must-haves of the stock market, likening it to a trend on the financial runway and challenging its logic. Beyond (or despite of) the editorial flair, the Rule of 40 is known today as one of the most popular metrics in SaaS valuations.
Originally a shorthand for evaluating the tradeoff between growth and profitability, the so-called Rule of 40 has evolved into something more: a practical benchmark in M&A, and a sign of business maturity in a capital-conscious market.
At L40°, we help founders interpret this metric and evolve it over time to make it a conversation starter and perhaps even a negotiation lever.
The Rule of 40 is simple:
Revenue Growth Rate (%) + Profitability Margin (%) ≥ 40
That margin is typically measured using EBITDA or free cash flow (FCF). The goal is to show that a company is either growing fast enough to justify lower profitability or profitable enough to offset slower growth.
Understanding how this metric is applied in real transactions helps founders anticipate buyer reactions and position their company more effectively during an exit process.
Private equity firms, growth investors, and strategic buyers increasingly use the Rule of 40 as a screening tool. Before reviewing a full data room or financial model, some might ask:
Is this business efficient enough to warrant deeper diligence?
From a founder’s perspective, this means the Rule of 40 could determine whether the deal conversation starts at all.
Valuation isn’t determined by one metric, but the Rule of 40 plays a central role in perceived capital efficiency. Investors want to know:
How much growth can this company sustain with the capital it consumes?
In both cases, a strong Rule of 40 performance can support:
While a business that’s compliant with the Rule of 40 is a good sign, it is also true that the Rule of 40 alone rarely tells the full story. Two companies can have identical Rule of 40 scores and still get very different valuations depending on factors such as:
High scores can also mask risk. For example, a company might show strong EBITDA margins driven by one-time cost cuts, or rapid growth fueled by a single enterprise account. In these cases, the Rule of 40 could look good on paper while raising concerns in diligence.
This is where execution meets narrative. To maximize outcomes, founders need to do more than hit a number, they also need to explain what’s behind it, how it’s changing over time, and why it will hold up under different market conditions.
A seasoned M&A advisor should help founders move from data points to deal story, ensuring the Rule of 40 becomes part of a broader, credible case for strategic value.
Recommended: Key Tech M&A Deals of 2024-2025
Improving your Rule of 40 is about building a more efficient business and demonstrating it in a way that investors trust.
The following levers can help strengthen both sides of the equation: topline growth and margin quality. The goal is to show progress as well as durability.
For companies leaning into growth, the key is to balance ambition with discipline. High growth alone does not signal quality. Buyers want to see growth that is targeted, efficient, and repeatable.
Below are a handful of strategies that founders can use to elevate the growth side of their Rule of 40 score:
Introducing new pricing tiers, usage models, or bundling strategies can lift average revenue per user (ARPU) without adding customer acquisition cost. Even small changes in pricing structure can meaningfully improve revenue efficiency.
A strong NRR engine often signals the healthiest type of growth. It also compounds over time and reduces reliance on new customer acquisition.
For SaaS, net revenue retention is one of the most scrutinized metrics.
Growth investment should be backed by clear CAC payback thresholds. Investors will evaluate whether the spend is translating into scalable, high-lifetime-value customers.
Improving the margin is about sharpening resource allocation to support a sustainable scale.
Founders might consider:
Many companies over-invest in underperforming channels or legacy initiatives. Redirecting capital toward higher-yield efforts such as efficient GTM or high-leverage product roles can improve margins without reducing capacity.
Tactics like automating onboarding, shifting to more scalable support models, or restructuring infrastructure costs can lift gross margin in ways that don’t affect product velocity or customer experience.
Streamlining administrative or back-office costs without touching R&D or sales productivity can improve EBITDA margins and signal operational maturity.
The most credible margin improvements are those that emerge gradually and hold up under scrutiny. Sudden margin spikes—especially right before a deal—can undermine trust.
A strong Rule of 40 score is most compelling when supported by a clear, consistent trajectory. Sharp shifts just before a raise or sale can raise red flags, even if the numbers are technically accurate.
Buyers and investors want to see:
Read: SaaS Multiples: Valuation Benchmarks for 2025
At best, the Rule of 40 is a strategic signal. But like any metric, it becomes meaningful only when supported by a thoughtful narrative and a track record of execution.
Founders should treat the Rule of 40 as a directional tool.
At L40°, we work with founders to turn performance into positioning. That includes preparing for diligence, shaping investor conversations, and using metrics like the Rule of 40 as credible levers during negotiations.
