The Rule of 40

August 6, 2024

The rule of 40 is one of many ways to evaluate a company. This rule is often used when evaluating start-up companies. The rule of 40 implies that early-stage companies with either low or negative profitability could still be reasonably priced at a high valuation level if their growth rate can offset their burn rate.

The rule of 40 combines the company’s profit margin and growth rate into a single number to help investors protect their downside risk. The company’s combined profit margin and growth rate should add up to 40%. For example, if a company is growing at 30%, then it should be generating a profit of at least 10%. If the company is growing at exactly 40%, it should be generating a 0% profit. If the company grows at 50%, the company can lose 10%.