A one-line health check that balances growth against profit — and the reason a fast-growing startup can lose money and still pass.
The Rule of 40 says a software company's revenue growth rate plus its profit margin should total at least 40%. It captures the core trade-off every growth business faces: you can grow fast, be profitable, or balance the two — but the combination should clear the bar.
Score = Revenue Growth Rate (%) + Profit Margin (%). Either lever can carry the score, which is why a hyper-growth startup with a negative margin can still pass.
A company growing 30% with a 15% margin scores 45 and passes. One growing 55% while burning cash at a −10% margin still scores 45 — high growth offsets the loss.
There's no single standard. Analysts use EBITDA margin, operating margin, or free-cash-flow margin. The key is consistency — use the same definition over time and when comparing companies.
Because the margin definition varies, always state which one you used when you report a Rule of 40 score.
The rule is most meaningful once a company reaches scale, roughly $1M+ in revenue. Very early startups routinely break it while investing heavily in growth, and that can be perfectly healthy.