Module II· Multiples & Sector SpecificsIntermediate

Question

What is the 'Rule of 40' and why is it relevant for SaaS valuations?

Answer

Mechanics

Rule of 40 = revenue growth rate (%) + EBITDA margin (%) ≥ 40%.

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Example

A SaaS name with 25% growth + an 18% EBITDA margin = 43 → passes. One with 50% growth + a (−15%) EBITDA margin = 35 → below.

Logic

A quality indicator that measures growth and profitability at the same time. A company can grow fast by burning cash or grow slowly but profitably — the Rule of 40 makes the trade-off explicit.

Application

A multiple premium for >40, a discount for <40. A central metric in VC / growth equity, and relevant in IB for late-stage SaaS valuations. Cross-check: if a buyer will pay >50% more for SaaS A than SaaS B, the Rule of 40 gap should justify it.

Pitch tip

'The target's Rule of 40 = 48 vs. a sector median of 38 — supports a premium multiple of 7.5x EV/Revenue vs. a median of 5.5x.'

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