Are we growing efficiently when growth and profitability are combined?
№ 014 · Rule of 40 trajectory
Definition
MetricARR growth rate plus profitability margin (EBITDA or FCF), tracked over time
Unitpercentage points (sum of two percentages)
Total line is revenue growth YoY plus FCF margin, tracked against the 40 threshold; the two thin lines show the components. Build by quarter. The mix matters as much as the total: growth handing over to margin is healthy, margin propping up collapsing growth is not. Example: 30% growth + 12% margin = 42.
- YoY
- Year on year. This period compared with the same period twelve months earlier.
- FCF
- Free cash flow. Operating cash flow minus capital expenditure.
Benchmarks
| Bottom 30% | Median | Top 30% |
|---|---|---|
| Under 10% | ~25% (CY2025), up from ~15% the prior year, the largest single-year gain in five years of benchmark data | 43%+ |
Private B2B SaaS and AI-native software, CY2025 actuals, EBITDA-margin basis most common; investors typically weight the metric only from ~$25M ARR because early-stage growth inflates it · Margin basis matters: EBITDA vs FCF can move the score several points; state which you use. Median Rule of 40 peaks for companies at $20-50M ARR and worsens above as growth decays faster than margins improve (Benchmarkit n=110). More than half the market remains below the 40 line; 40 is a top-third bar, not a median.
| Category | Bottom 30% | Median | Top 30% |
|---|---|---|---|
| By ARR band (median score) | any band: under 10% | $20-50M ARR posts the highest band median; above $50M scores decline as growth decays faster than margin gains | $20-50M ARR: 40%+ |
When it looks bad
The trajectory slides down-left along the growth axis: each period trades several points of growth for one point of margin, so the sum falls even as the company gets more profitable.
Year 1: 40% growth, -10% margin (30). Year 2: 25% growth, -2% margin (23). Year 3: 15% growth, +3% margin (18). Cost cuts are winning the battle and losing the score.
What to do about it
- Diagnose which component broke: a falling score with stable growth is a cost problem (usually headcount pacing); a falling score with improving margin is a growth problem, and further cuts deepen it; the ICONIQ finding that growth is ~2x as valuation-impactful as margin says which side to fix first.
- Buy growth through retention, the only lever that improves both components at once: higher NRR adds growth (SaaS Capital: +5 points per NRR band) with near-zero marginal cost, so it raises the sum from both ends.
- Track the trajectory on both EBITDA and FCF bases; a score built on EBITDA while deferred revenue shrinks and collections stretch is borrowing from next year's line.
- If under $20M ARR, report the score but do not steer by it: ICONIQ and Benchmarkit both treat it as meaningful from roughly $25M ARR, and below that CAC payback and growth rate are the honest gauges.
Sources
- Aleph and Benchmarkit Median 25% in 2025 (from 15% in 2024); top quartile clears 43% getaleph.com ↗
- ICONIQ Growth Rule of 40 weighted only from ~$25M ARR; efficiency shift since 2022 has gradually improved scores; AI adopters may position toward Rule of 60 iconiq.com ↗
- McKinsey Rule of 40 performance strongly linked to valuation multiples; NRR 120%+ cohort at 21x median EV/revenue vs 9x mckinsey.com ↗
- ICONIQ Growth Growth is roughly twice as impactful as profitability alone on forward multiples, but Rule of 40 remains highly correlated with valuation; companies projecting stronger scores in 2025 iconiq.com ↗
- Benchmarkit Rule of 40 tracked with EBITDA and FCF variants; highest median for $20-50M ARR companies benchmarkit.ai ↗
- KeyBanc Capital Markets and Sapphire Ventures Growth reaccelerating to ~20% alongside sustained profitability focus, the combination that lifts Rule of 40 sapphireventures.com ↗