What Is the Rule of 40 for SaaS?

By Jeremy Bowman – Updated Jun 7, 2025 at 6:51 PM | Fact-checked by Robin Hartill, CFP

Key Points

The Rule of 40 measures software firms' investability by adding revenue growth and free-cash-flow margin.
Companies that exceed a combined score of 40%, like Palantir, are viewed as financially healthy.
Investors should use additional criteria beyond the Rule of 40 to assess a company's full financial health.

If you follow the software industry, you've probably heard talk of the Rule of 40. This is a shorthand rule of thumb for assessing whether a software-as-a-service (SaaS) business is investable.

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What are the rules is written in chalk on a blackboard. — Image source: Getty Images.

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About the Author

Jeremy Bowman has been a contributing Motley Fool stock market analyst, covering technology, consumer goods, and macroeconomic trends since 2011. Before The Motley Fool, Jeremy was a newspaper reporter, restaurant manager, and English teacher abroad. He holds a bachelor’s degree in English from Colorado College and a master’s degree in business administration from American University. One of his Motley Fool headlines was briefly featured on Late Night with Stephen Colbert.

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Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Palantir Technologies. The Motley Fool has a disclosure policy.