The Rule of 40 and the people who think it is wrong
The rule was a heuristic overheard in a board meeting and blogged in 2015 by two venture investors who did not invent it — and its most prominent critique now comes from Bessemer, the same firm that spent years promoting the rule as an industry benchmark in its own reports, which is worth knowing before you cite either version as settled.
Somebody will say “Rule of 40” in front of you, and the way they say it will suggest a settled industry standard with research behind it. It is a blog post from 2015 whose author credits a rule of thumb he overheard, scoped to a size of company most portfolio software businesses are not, using a term the author says nobody has agreed on. All four of those facts are in the post itself.
What the post actually says
Brad Feld published it in February 2015. He states the rule as “your growth rate + your profit should add up to 40%”, and he is explicit that it is not his. He credits “a late stage investor” at a board meeting who described it as what that investor’s firm called the 40% rule for a healthy software company. The investor is unnamed and the firm is unnamed, in the post and in everything this course could find. So this lesson names neither. A rule of thumb from an anonymous person in a room in 2015 is a perfectly reasonable thing for it to be; pretending to know whose it was would be worse.
Two caveats travel with it in the original and almost never survive the retelling.
- Scale. Feld scopes it to SaaS companies at scale — assume at least $50 million in revenue — while noting the pattern correlates nicely from roughly $1 million of monthly recurring revenue upward. A rule quoted at a company well below that is being applied outside the range its author claimed for it.
- Profit is undefined. Feld asks directly whether the term means EBITDA, operating income, net income, free cash flow, cash flow or something else, and then states his own preference for EBITDA as the baseline. A preference is not a definition, and he does not present it as one.
That second caveat should land hard after the P&L lesson. EBITDA is already a non-GAAP construction with rules about honest presentation. The Rule of 40 puts an undefined profit term into a two-variable sum and gets quoted as though the output were a fact about a company. It is a construction built on a construction.
A second post from the same period, by Fred Wilson of Union Square Ventures, circulated the same idea from the same overheard moment. This course did not open it, so nothing here rests on it and no quotation from it appears. Between them, those two 2015 posts are why the phrase is in general circulation — and neither author invented the rule.
The critique, and who is making it
The substantive objection comes from Bessemer Venture Partners, in a piece by Byron Deeter and Sam Bondy called The Rule of X. Their claim is about weighting: “assigning equal weighting to growth and profitability for late stage businesses is flawed”, and more bluntly, “the traditional Rule of 40 math is dead wrong as you approach breakeven and turn free cash flow positive”. Their replacement multiplies the growth term before adding it to free cash flow margin, at roughly 2x growth over profitability for late-stage private businesses and roughly 2 to 3x for public ones.
They scope their own rule too, which is worth noticing in a document arguing that somebody else’s rule is unscoped: they say it is harder to apply the Rule of X math to earlier-stage private businesses growing above 125% and burning above 75%.
Now the part that is usually told wrong. The critique does not come from the people who popularised the rule. It comes from a firm that popularised it later, in a different way: Bessemer spent years using the Rule of 40 as a headline benchmark in its own State of the Cloud reports, including the 2023 edition this module quotes elsewhere for retention and payback bands, and has now reversed that position in print. One firm, two published positions, several years apart.
How much the weighting changes the answer
The following two companies are the course’s own invention, chosen to sit at the same Rule of 40 score. The 2x multiplier is Bessemer’s own stated figure for late-stage private businesses. Nothing here is a benchmark or a real company.
Growth FCF margin Rule of 40 Rule of X (2x)
Company A 20% 20% 40 60
Company B 35% 5% 40 75Under the rule, these two are identical and the choice between them is a matter of taste. Under Bessemer’s version, B is well ahead. That is the entire disagreement, made small enough to hold: whether a point of growth and a point of margin are worth the same. The Rule of 40 says yes by construction. It does not argue for it, because it was never an argument — it was a heuristic somebody used in a board meeting.
What you can and cannot do with this in a case
A UI change does not move a company-level score directly. It reaches one of the two terms through the routes you already know: cost of revenue and research and development touch the margin term, retention and expansion touch the growth term, and each of those is a chain of several links before it arrives. Claiming a Rule of 40 effect for a design change means claiming every link at once.
So the honest uses are narrow, and they are mostly defensive.
- To read the room’s frame. A company running near breakeven is being watched on the profit term, which tells you which of your four routes will be heard.
- To decline a bad claim gracefully. “This does not move the Rule of 40 by any amount I can defend” is a strong sentence. It costs you a number you could not have supported anyway and buys the room’s attention for the claim you can support.
- To ask which version is in use. If somebody cites the rule as a target, asking whether the profit term is EBITDA or free cash flow is a fair question with Feld’s own post behind it.
Check your recall
Answer from memory — no scrolling back.
Retrieval check
Someone in a review says “does this help the Rule of 40?” Answer in two sentences without overclaiming and without sounding evasive.
Check your answer
Something close to: not measurably, and I would not claim it. The effect I am arguing for sits in cost of revenue, which touches the profit term several links downstream, and I cannot size that link with anything I have.
The second sentence is what stops the first from sounding like a dodge. You are not saying the work does not matter; you are saying exactly where it enters and exactly which step you cannot quantify. Somebody in that room can size that step, and now they know which one to size.
Hands on
Write the folk version and the real version side by side
Done when: A note in VALUE-CASES.md states the Rule of 40 as it is usually quoted and as Feld actually wrote it, listing the three caveats the folk version drops, plus one sentence naming who publishes the main critique and what their interest is.
- Write the folk version first, in the words you have actually heard someone use. Getting the sloppy version down is the point — it is what you are going to have to answer.
- Under it, write the original: the sum, the credited source, the revenue scale, and the fact that the profit term is unsettled. Four short lines.
- List the caveats the folk version drops. There are three worth naming and they are all in the post.
- Add one sentence on the critique: what Bessemer argues, and the fact that Bessemer promoted the rule as a benchmark before reversing. Name the interest as well as the argument.
- Bring the two versions into the chat and I will play the person who quotes the folk one at you. The goal is answering without either conceding the point or sounding like you are correcting somebody for sport.
What this does not cover
This lesson deliberately did not give you a way to claim a Rule of 40 effect, because there is not an honest one available to a UI change on its own. That absence is the bridge to the last lesson in the module, which turns it into a method: going metric by metric through ARR, retention, payback and this score, and writing down which ones your change cannot move before anybody has to ask you. After that, the case itself — four fields on one page, starting with the hypothesis.
Read this next — primary source
The Rule of 40% For a Healthy SaaS CompanyBrad Feld, Feld Thoughts, February 2015 — free
Read the post that put this rule into circulation, because it is far more modest than its reputation. It is short, it credits somebody else for the idea, it states a revenue scale below which the author does not claim the rule applies, and it openly concedes that the word “profit” in it is undefined. Every one of those four caveats is missing from the version you will hear quoted in a meeting. Reading the original is the cheapest possible inoculation against repeating the folk version.
Stuck, curious, or think this lesson is wrong? Ask your teaching agent. The lessons are the scaffold; the conversation is where the learning gets unstuck.