Rule of 40 — I don’t see you

The Rule of 40 is a very popular term and concept at the moment. We hear founders focusing on it, doing whatever they can to generate growth and profitability. But is it real or just an outdated rule of thumb? The data suggests the latter.

Below is every publicly traded company we monitor. It encompasses 108 names. Summing their average EBITDA margin (-3%) and growth (15%, both in yellow) doesn’t get you 40%. It gets you only 12%, yet these companies have an average multiple of 7.27x. Looking at the medians, summing EBITDA margin (0%) and growth (16%) gets you only 16%, and the median multiple is still 5.72x. Where is the Rule of 40?

If we look at only those companies that are growing above the median (highlighted in green), we’re seeing more like the rule of ~16%, and these companies aren’t profitable on median and average. The average and median multiples for these companies is 10.2x and 8.6x. Where is the Rule of 40?

Finally let’s look at all cash acquisitions of publicly traded companies. Again, summing median EBITDA margin (0%) and growth (19%) gets you only 19%, yet the median acquisition multiple is 8.9x. The average shows similar trends (sum is 18%), yet the average multiple is 10.3x.

So where is the Rule of 40? The data certainly isn’t supporting it. Our advice to founders is to continue to push hard for cash-efficient growth. That means generating ARR of at least $0.70 for every dollar of operating loss. Don’t destroy your growth just to get to profitability, or break something trying to get to the Rule of 40, which we don’t see anywhere in the data.

Thank you for your readership. Visit us at blossomstreetventures.com for more articles and SaaS data.