The SaaS Rule of 40 Explained Simply

August 27. 2023. 1 min read

The SaaS Rule of 40 is used by investors of all types to gauge the health of a SaaS company. Just spouting off the basic formula – growth rate plus free cash flow margin – isn’t sufficient. Most people could care less what a free cash flow margin is so we explain everything quite simply. Using a few examples, we show you how to arrive at free cash flow, how to calculate free cash flow margin, and how to put the whole thing together. Just hitting the Rule of 40 isn’t enough, you need to consistently maintain it. Very few companies can do this, and we look at some research from leading consulting firms which shows how difficult this feat is and how companies that exceed the Rule of 40 are ascribed higher valuations by the market. And yes, we provide some names of stocks to watch that hit the Rule of 40 and then some. This is the SaaS rule of 40 explained simply – just how it should be.


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