Using the Rule of 40 to plan an exit
Why buyers use it
The Rule of 40 compresses the central trade-off in software, growth against profitability, into one number. It lets a buyer compare a fast-growing, loss-making company with a slow, profitable one on the same scale, and it correlates closely with the multiples public and private software companies actually trade at.
Score bands
| Score | Buyer read | Typical private ARR multiple |
|---|---|---|
| Below 20 | Needs a fix plan | 1.5x to 3.5x |
| 20 to 39 | Solid, one lever to improve | 3.5x to 6x |
| 40 to 59 | Passes, competitive process | 6x to 8.5x |
| 60 and above | Top decile | 8.5x and above |
Timing the exit
Buyers pay for the trajectory, not just the snapshot. Two or three quarters of rising score before a sale is worth more than a single strong quarter. Check how AI exposure affects the same multiple with the AI displacement risk index (opens in a new tab), and compare likely offers in the exit simulator (opens in a new tab).
Frequently asked questions
- What is the Rule of 40?
- The Rule of 40 says a healthy software company’s revenue growth rate plus its profit margin should be at least 40%. A company growing 30% with a 10% EBITDA margin scores 40; one growing 50% with a -10% margin also scores 40.
- Which margin should I use?
- Most investors use EBITDA margin for private companies and free cash flow margin for public ones. Use the same measure consistently over time, and say which one you used when you share the score.
- How does the Rule of 40 affect valuation?
- It is one of the strongest predictors of software multiples. Each extra point of score is typically worth around 0.1x to 0.15x ARR in private markets, so a company scoring 50 can be worth roughly a third more than one scoring 30 at the same revenue.
- Is growth or profit worth more?
- At most scales, a point of growth is worth more than a point of margin, because growth compounds. As companies mature or capital becomes more expensive, buyers place more weight on margin. The simulator compares both levers at your numbers.
- Does the Rule of 40 apply to early-stage startups?
- It is most meaningful above about $5M to $10M of ARR. Earlier, growth rates are volatile and investors look more at retention, payback and burn multiple.
- What is a good Rule of 40 score?
- Above 40 passes. Above 60 puts a company in the top decile of public and private SaaS. Below 20 usually means buyers will focus on a plan to fix either growth or efficiency before paying a full multiple.