Improving the Rule of 40: How Growth and Profit Impact SaaS Company Valuations

Abstract

This study examines and seeks to improve the Rule of 40. The Rule of 40 is a commonly used benchmark for valuing Software-as-a-Service (SaaS) companies and has grown in popularity amongst software investors since 2015. The Rule of 40 states that a SaaS company’s revenue growth and profit margin should exceed 40%. SaaS firms have many complexities that make them difficult to value using traditional methods. This analysis uses multiple linear regression models to determine the appropriate weights for revenue growth and profit margin metrics and employs a dataset of publicly traded North American SaaS companies spanning from 2015 to 2025. Additionally, different profit margin metrics such as EBIT margin, EBITDA margin, and Free Cash Flow margin were tested in the models to see which has the most significant effect on value. By segmenting the data based on company size and macroeconomic conditions, the study reveals how the relationship between growth, profit, and company value changes. The key findings of the study suggest that revenue growth has a strong positive impact on value, especially amongst smaller companies and in low-interest rate environments. Profitability was found in general to have a negative effect on a firm’s value. EBIT margin and EBITDA margin were robust predictors for most groups, while Free Cash Flow margin gained importance in the larger company samples.