REVOPS TRAINING

Rule of 40

A heuristic that revenue growth rate plus profit margin should sum to at least forty, used to judge whether growth and profitability are in a defensible balance.

The calculation

Year-over-year revenue growth rate plus profit margin, both as percentages. Forty is the conventional pass mark.

Three ways to score 40
GrowthMarginScoreWhat kind of business
60%-20%40Funded, buying growth
40%0%40Growing at breakeven
10%30%40Mature, profitable

Source: Illustration

The assumption doing the work

Adding the two implies they substitute one-for-one. They do not. A point of margin bought by cutting acquisition costs future growth, and the delay is exactly what makes the score improvable in a quarter at next year's expense.

Using it well

  1. Name the margin. EBITDA, operating and free cash flow are not interchangeable, and the difference decides whether you pass.

  2. Read the components, not the total. 60/-20 and 10/30 are entirely different businesses with the same score.

  3. Track the trend rather than the level. Direction is more informative than whether you cleared an arbitrary threshold.

  4. Ignore it at early stage. The rule was derived from mature software companies and does not describe a business still finding product-market fit.

Where it misleads

  • It says nothing about retention. A business growing on heavy acquisition with poor retention can score well while the base leaks.

  • One-off revenue inflates growth for a year and then reverses.

  • It is a whole-company measure, so it cannot tell you which segment or motion is carrying or dragging the score.

RELATED TERMS

Burn Multiple

Net cash burned divided by net new ARR added — how much cash is consumed to produce a unit of recurring revenue.

Gross Margin

Revenue minus cost of goods sold, as a percentage of revenue. Whether the business model scales.

Magic Number

A sales efficiency measure comparing new recurring revenue produced to the sales and marketing spend that produced it.

COMMON QUESTIONS

What is the Rule of 40?
Growth rate plus profit margin should exceed 40. A company growing 60% at -20% margin scores 40, as does one growing 10% at 30% margin.
Which profit margin should you use?
State it. EBITDA, free cash flow and operating margin all get used, and they can differ by many points on the same business — a score quoted without naming the margin is not comparable to anything.
Is the Rule of 40 a good operating target?
As a check, yes. As a target, no: it implies growth and margin trade off one-for-one, which is false. Cutting acquisition raises margin immediately and lowers growth later, so a score can be improved in a quarter by mortgaging the next year.
Does it apply to early-stage companies?
Poorly. It was derived from later-stage software businesses. A company growing 200% at deeply negative margin fails it while doing exactly the right thing.

Learn how to apply this: RevOps 101: Revenue Operations Foundations

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