Rule of 40
Definition
The Rule of 40 is a SaaS rule of thumb: a healthy software company's revenue growth rate plus its profit margin should sum to at least 40%. A company growing 60% while burning at a −20% margin passes (40); one growing 10% with a 35% margin also passes (45) — the rule formalizes the trade-off between growth and profitability.
Conventions vary on both inputs: growth is usually year-over-year revenue (or ARR) growth, and margin is commonly free-cash-flow margin or EBITDA margin, sometimes operating margin. Because definitions differ, the metric is a screening heuristic, not an accounting standard.
Investors use it to compare companies across the growth/profitability spectrum, and empirically Rule-of-40 performance has correlated with software valuation multiples — with markets at times weighting profitability more heavily than the rule's one-for-one trade implies.
Why interviewers ask
TMT and growth-investing interviews use it as shorthand for SaaS health: expect 'what is the Rule of 40 and does Company X pass?' Knowing that it is a heuristic with varying margin definitions — and being able to do the arithmetic instantly — is exactly the calibrated answer interviewers want.
Related terms
Interviews don't test definitions — they test recall under pressure.
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