The rule of 40 is a quick way to measure how a CEO is balancing growth versus profitability. It says that a CEO can burn as much as they want (Free cash flow margin negative) as long as their growth (revenue growth rate positive) is 40 percentage points higher.

Your E40 for last year = free cash flow margin + revenue growth rate

I focus on private b2b saas companies and collect this data by interviewing the founders directly. Of the 1424 interviews I’ve done, several hundred CEO’s have chosen to share growth or burn. Below, I’ve plotted those CEO’s who’ve shared both.

Rule of 40 Graph; Private B2B SaaS Companies

Source: SaaS CEO’s interviewed on The Top Entrepreneurs Podcast

Words of caution

• I generally think CEO’s get in trouble when they start thinking about E40 way too early. If you’re a $10m ARR company looking to drive growth, you might sacrifice margin while you figure out customer acquisition channels that scale.
• Bootstrapped CEO’s may sacrifice growth to drive free cash flow so they can pay themselves dividends. Perfectly fine way to build wealth. Just don’t raise and get on VC track.
• PerectCloud has an EBITDA margin of 12.35% and a growth rate of 100% for E122.4 however its ARR is just north of $20m.  The company is bootstrapped so if founder wanted to run it at 0% growth but 20% FCF margin over next 12 months and get rich paying out a dividend, nothing wrong with that.
• Don’t blindly apply this chart to your startup. Rather, use it as an instrument to guide, not direct.

When should you start to target E40?

• If you’ve raised VC and are on the IPO or bust track, you’ll want to trend back towards E40 has your cash runway starts to sink under 12 months. This will put you in a strong position for next round of funding because it’d say that you successfully invested (FCF margin negative) the last round of funding to drive growth (Revenue growth rate TTM).

Interested in public market Rule of 40 Trends?

• Read this piece from Dave Kellogg where he analyzes report from Piper Jaffray on public Rule of 40 comps.
• Read this piece from Jared Sleeper on how investors think about free cash flow versus growth in the public SaaS market.
• Brad Feld back in 2015, one of the first e40 posts out there.
• The SaaSCFO did a nice writeup on how to calculate here.