In 2015 Brad Feld mooted the idea of the Rule of 40% for SaaS companies. The rule states that “your growth rate + your profit should add up to 40%. So, if you are growing at 20%, you should be generating a profit of 20%. If you are growing at 40%, you should be generating a 0% profit. If you are growing at 50%, you can lose 10%. If you are doing better than the 40% rule, that’s awesome.”
So is there data to back this assertion up? Enter Tom Tunguz. A few days after the above post, he calculated what he called the “GP” metric for all publicly traded SaaS companies over their lifetimes. It showed that the metric stands the test of time with GP being as high as 100% in the early years and stabilizing at around 30% in the mature 12-15 years. The median of 40% is in the 5-7 years range.
This means if you want to get a feel of how your SaaS business is doing, you should look at the GP ratio at a 100% + level in the first couple of years (with low base figures this is actually a reasonable ambition) and then stabilise around 40% in years 4 to 6. This should certainly set you apart and make you attractive to investors.
Read Brad Feld’s post on 40% rule here : https://feld.com/archives/2015/02/rule-40-healthy-saas-company.html
Tomasz Tunguz follow up piece, here : https://tomtunguz.com/rule-of-40/
