Rule of 40 R40
A rule of thumb that a healthy software company's growth rate plus its profit margin should sum to at least 40%.
The fork, why two teams get different numbers
Neither input has a fixed definition, so "Rule of 40" is really a family of
scores. Growth: year-over-year revenue growth vs ARR growth vs forward run-rate
growth. Profit: EBITDA margin vs FCF margin vs operating margin vs Adjusted
EBITDA margin. A growth-stage board pairs ARR growth with FCF margin; a
public-markets investor pairs recognized-revenue growth with FCF margin; a
founder picks whichever combination clears 40. The same company scores 38 or 46
depending only on the pairing.
The trap
Because both inputs are choosable, a company clears 40 by mixing its best growth measure with its best margin measure, and the two can double-count (ARR growth that includes non-recurring revenue, plus an adjusted margin that adds back the cost of earning that revenue).
- The full trap, worked on a real export
- Every formula variant, spelled out
- The reconciliation anchor, what to tie it to and when to refuse
Reference: Non-GAAP composite operating metric, no authoritative standard · SEC MD&A guidance on consistent metric definitions