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Why the Rule of 40 is No Longer Good Enough

You're probably familiar with the "Rule of 40," but did you know that it might be outdated? Let's dive in and explore!

Software finance professionals know the rule - your profit margin plus your growth rate should add to at least 40. This guideline, aptly named the Rule of 40, is repeated on seemingly every SaaS blog.

However, in recent years, the shifting market has rendered this rule essentially obsolete.

The top SaaS companies now far outpace the Rule of 40 in terms of valuations. Why did this shift occur, and what does it mean for your SaaS software company?

Rule of 40 or Rule of 60?

Your Rule of 40 metric isn’t critical when you’re early on - in the beginning, it’s your burn multiple that truly matters.

You need to start thinking about your score once you reach around $50M in ARR. Software like Subscript makes this process easier by putting all your SaaS metrics at your fingertips. If you’re not using Subscript, the calculation will require a deep dive through the spreadsheets you use to track your SaaS metrics.

At the $50M ARR mark, a higher Rule of 40 score usually means higher multiples in the public markets. While the number 40 used to be correlated with high valuations, today’s market calls for a score of 60.

Why is that?

Because in recent years, the rise of product-led growth companies (PLGs) has changed the landscape of the market. PLG companies like Zoom, Canva and Slack have very high profit margins due to their efficiency and public markets have taken notice.

Sales Driven Companies, The Rule of 40, and Valuations

So what about sales-driven companies? Are they doomed to fail?

We’ll cover the bad news first - many sales-driven companies are facing lower SDR efficiency than in the past, partially due to the fact that there are so many SaaS companies competing for the same customers. Consider outbound emails, for example - a strategy that’s become less effective for many companies in recent years now that executives’ inboxes are fuller than ever.

On the flip side, software budgets are larger than they’ve ever been. As a result, SaaS companies grow faster despite going public later (including those with a direct sales model) and continue to be popular with the public markets. In other words, there’s still plenty of potential for growth in a sales-driven company.

Despite being less efficient, direct sales companies should still aim for a score of 60. While the score is more challenging to achieve, it’s still necessary to maximize valuations.

Subscript can Help

Without a convenient way to store and track metrics, figuring out your Rule of 60 score is a headache. Subscript keeps all your data in one place to save you the hassle of spreadsheets and inaccessible dashboards.

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