Fig. 01 · Glossary
Rule of 40
Also known as Rule of Forty, R40
Definition
The Rule of 40 says a software firm's annual revenue growth percentage plus its EBITDA margin percentage should total 40 or more. A firm growing 50% with -10% EBITDA hits the rule (50 + -10 = 40); a firm growing 20% with 20% EBITDA also hits it (20 + 20 = 40). PE buyers use the Rule as a coarse filter for institutional readiness; venture growth investors use it as a metering signal between hypergrowth and capital efficiency. Failing the Rule below $50M ARR is recoverable; failing it above $50M ARR signals a structural problem with unit economics or capital-deployment discipline.
The Rule of 40 is a heuristic, not a model. Two firms can both score 40 with very different operational realities. A 60% grower at -20% EBITDA is burning cash to acquire revenue; a 5% grower at 35% EBITDA is harvesting an installed base. The valuation multiple the market assigns each is dramatically different despite identical Rule scores — the market discounts low-growth profitability because it implies a near-term ceiling.
Operationally, Rule-of-40 work splits into two playbooks: if you fail the Rule because of growth, the work is GTM Execution and Revenue Architecture (where 90% of misses live). If you fail because of margin, the work is Unit Economics and Financial Infrastructure (where the misses are usually CAC overspend or pricing discipline).
Human Renaissance glossary · operator-grade definitions · Research methodology
