The Rule of 40 Becomes the Rule of 60

Live from Schenectady, New York, it's the Metrics Brothers, Growth and CAC.

And I'm Growth, better known as Ray Reich, founder and CEO of Benchmarkit.

And I'm CAC, better known as Dave Kellogg, EIR at Balderton Capital, independent consultant, and the author of CalBlog.

And together we are the Metrics Brothers.

And we go together like term sheets and covenants.

What? What type of term sheets have covenants?

Well, debt, debt ones specifically, but the kind in general also that they issue when the music stops, right?

Ah, so are we talking about private credit today?

No, no, we're not. Even though you brought it up on our recent Citrini episode, and I think it is a good topic for another day. 'Cause things are a little bit more subtle than I knew. But meantime, if you wanna know what I'm reading to learn about that topic, go read the Money Stuff newsletter by a guy named Matt Levine from Bloomberg. And he did a piece recently on private credit that really explains this idea of a business development corporation, which helps explain what's going on with private credit right now. 'Cause basically I thought it was long-term money that was locked up, so how could it have a bank run? And the answer is it's not so long-term via these BDCs. But anyway, that's not what we're talking about today, Ray. Let's make that another episode. Today, I want to talk about the evolution of a metric. And do you know which one we want to hit?

Well, I bet you want to talk about one of my favorites from a long time ago, I think 2015, the Rule of 40, and how it's becoming something more like the Rule of 60 in certain environments.

Well, it is definitely moving to the Rule of 60. And certainly in the PE environment, we can talk about, it was really more of a PE rule the whole time, in my opinion, and all VCs talked about it. But yeah, today I want to talk about the Rule of 40, how it's evolving to the Rule of 60, and specifically why it's evolving to the Rule of 60, because I think that's the most important part of the episode. Because once you understand why, you understand why it's not going away.

Well, before we do that though, let's hear a word from our sponsor. The Metrics Brothers is proudly sponsored by Benchmarkit, the B2B AI and software industry's largest, broadest, and most contextualized benchmarking index. Dave Kellogg and Ray Groth Wright have put the Metrics Brothers podcast on hiatus for the remainder of 2026. All episodes we have ever recorded are still available on your favorite podcasting app. You can reach Dave @kellogg and Ray on LinkedIn @rayreich. Thank you so much for listening to the Metrics Brothers podcast. Okay, Dave, you want to start just with the Rule of 40 refresher?

Yeah. So today we're going to talk about something deceptively simple, but actually pretty profound for SaaS economics. And our thesis today is basically that the Rule of 40 is no longer enough and that we are entering the Rule of 60 world. But as you asked, let's do a quick refresher on the Rule of 40. Do you want to do it, Ray? You want me to do it? Should I boom it right in the back?

Yeah, let me do it. Being a member of the SaaS Metric Standards Board, we defined this. It's taking the growth rate plus the really operating profit margin, and it needs to be equal to or greater than 40. Now, most companies are using free cash flow margin as the margin measurement. Some use EBITDA as a proxy for that, Dave. So either or. So—

Ray can't help the weeds. We're going to call you the weed whacker. Look, look, I want to start with the high level, then we'll do the weeds. The high level is it's growth plus profit equals Rule of 40 score. And then the question is growth in what? Revenue, ARR, subscription revenue, right? And the question is, well, what profit metric? Operating margin, EBITDA margin, adjusted EBITDA margin, free cash flow margin. So Ray's right, of course. But, but the simplest way to think of it is it's growth plus profit equals Rule of 40. And then, yeah, there's a drill down. And I think we'd agree that we use revenue growth and free cash flow margin. What do you— is that what you use?

That is right. That is what I use.

Got it.

And the nice thing about it, hey, you can have 50% revenue growth. You can be losing 10% on a free cash flow margin. You're still at a Rule of 40, or you can be growing at 20%. And you can have a 20% free cash flow margin, you're still at the Rule of 40. It's really just a way to measure—

It even scales to hypergrowth, right? You could be growing at 140%, uh, and be having negative 100% free cash flow margins, right? That's why people like the Rule of 40, because it represents this spirit of balance, and it's actually quite scalable. It is.

But one of the questions, kind of, where did this emanate from? Where did it start, Dave?

Yeah. So we're going to try and do a history lesson without getting too, too lost in the weeds. Most of the audience knows about the Rule of 40 already. So I want to focus on the transition to Rule of 60, but in case you're new, and also let's, in case you don't know all the history, let's try and look at this through historical lens. So first, you know, in the beginning there was SaaS and it was good. You know, Salesforce was founded in 1999. And then I think the next major thing that happened was a global financial crisis in 2008, which resulted in interest rates coming down to near zero. And that began the growth at all costs era and the ZIRP era of SaaS, meaning ZIRP, zero interest rate phenomenon. So, in the— around 2008, SaaS companies were still relatively new. Right. But money was cheap, cheap, cheap, cheap, cheap. And SaaS markets were kind of greenfield. So what happened was people said, let's grow and grow fast, right? Raise capital, acquire customers, capture market share. It's a greenfield market.

And then I think around 2015, which is the end of that first year that you're talking about, That '08 through '15, that's when Brad Feld, a venture capitalist, wrote about it. And he said, hey, we want to start asking about balancing growth and profitability. So that was the first time the Rule of 40 really hit the public environment, right? When I say public, people started talking about it and measuring it.

Slight oversimplification, but I'll say this, Brad Feld took the punchbowl in 2015, right? He didn't quite, because people ignored it initially, but Brad Feld did write in 2015 that maybe we should look at a balance of growth and profit, that maybe it's just looking only at growth is not the right answer. That wasn't 2015. And just, Ray, I want to try and use Salesforce stock as an indicator on this history lesson. It's not perfect, but, but it's real. So let's talk about it. At the end of 2008, Salesforce stock traded for $8 a share, $8.30. At the end of 2015, it traded for $68, right? So a 7 plus X multiple During that 7-year period. So massive returns. Then we hit, as Ray said, kind of the era from 2016 to 2021, right? Which we're going to call ZIRP 2 because rates came up but not that high. They got as high as I think 2.5% in 2017, 2018. So you had during this period from 2016 to 2021, Salesforce started at $68 a share And they ended at $255 a share, right? In this 5-year period, by the way, it peaked in November of 2021 at $306 a share. So we had interest rates that were historically low. COVID provided a boost to that, right? Rates had crept up and then COVID hit, rates went back to zero, and SaaS really became the dominant business model.

And at the same time, I still remember during that COVID era, kind of second half of 2020, 2021, The amount of VC coming into SaaS companies, it just flooded the market. I think it was up almost 2.5 to 3x in 2021 versus 2019.

So it was also amazing. Companies too, right? Right. Like PE was booming then because people were getting exits. I invest in PE funds and I work with some PE companies and, and I had some very good years in the first 2 years of COVID right? Because liquidity was everywhere. And when money's cheap, it's not just cheap Look, it's not just more available, but it's cheap to borrow. So a lot of the PE companies borrow money to buy their SaaS companies. And that was also part of it. So let's take it now to the 3rd era. So basically, the Rule of 40 was born out of this kind of melee, which is we had this growth at all costs era. And people enter this period where they're going back and forth saying, should we be balanced? Nah, heck, let's just go for growth. Should we be balanced? Heck no, let's just go for growth. And then we end up in, and then COVID happens, rates get cut again, people go crazy, right? But then we hit 2022, Salesforce stock is now down to $132 a share at the end of 2022. So it peaked in November '21 at $306, right? It's now down at $132 because inflation starts to come, interest rates rise, this cheap capital that made money more available And that made borrowing cheaper for PE firms wanting to buy SaaS companies with leverage. All of this kind of reset overnight.

And I don't know if we want to talk at all about R-squared and, and that correlation measurement of how it was impacted more by growth during that kind of ZIRP era, and now it's more focused on Rule of 40. And maybe that's going down a rabbit hole, Dave.

You could try it, Ray. Why don't we do that? So look, So, so, so the narrative that's led us here is the one I just covered, so I won't review it again. Ray's touching on an interesting point, which is should growth and profit get equal time or equal treatment or equal weight in calculating this Rule of 40 score? And, you know, the first people that said otherwise that I ever heard was a small boutique investment bank in San Diego called the Software Equity Group that did a 2x growth weighted rule of 40. Then Bessemer came along years after that. I think it was 2024 with the rule of X and they did kind of an impact factor analysis. So yeah. So Ray, why don't you talk more about that topic?

Yeah. Well, I think what's interesting and it's really how does growth correlate to the enterprise value to revenue multiple? So back in the go-go days, it was as high as Growth was 11 times more important than free cash flow margin at one point. Right now, if you look at Meritech, and they use something called the Meritech Rule of 40, which is just like the Rule of X and the SEG. Right now, the Meritech Rule of 40's correlation to enterprise value to revenue multiples is 0.63, and the R squared is anywhere from 0 to 1. So 0.63 is pretty highly correlated. But here's what's interesting, Dave. The growth correlation to the enterprise value to revenue multiple is 0.55, and the free cash flow margin is only about 0.16. So right now, growth is almost 3.7 times more important to enterprise value to revenue multiples than free cash flow margin. A lot of words there, but growth still matters a hell of a lot more than free cash flow margin today from a multiple perspective.

Yeah, so a couple of things. R squared is not a measure of correlation, it's kind of a measure of explanatory power, so is the way I think of it.

So— You're right, it's coefficient of determination is what it's actually called.

Yeah, yeah, so it's more explanatory power because the correlation itself could be negative, right? You could have a perfect R squared, but the correlation would be negative. So yes, I agree with everything you said. I agree with the fact that if you do a multifactor regression, you will determine which growth or profit has more of an impact in predicting or has more explanatory power in predicting the enterprise value to revenue multiple, which is what investors like to do with these things, right? They want to say, well, if I want to make the valuation go up, what's the metric I should focus on? And You know, how many points of up do I get for a point of improvement in the metric? So, and in fact, what Ray talked about is what I actually use as a bubble indicator. I kind of do this all backwards. I say whenever growth is 3 or more times more impactful than profit, then we're kind of in a bubble. And because the norm, if you look at the Bessemer data, is around 2.3. So my line is always that, hey, a point of profit is worth 2.3 points of growth. So if I were to make a growth-weighted R40 of my own, the Dave Kellogg one would rate growth at 2.3 as opposed to the, the SAG one, which rates it at 2.

But what's interesting, Dave, and I kind of want to get to how we're moving to the Rule of 60, but right now in the public SaaS markets, and I know these are the Ivy League kind of schools, their balance between growth and free cash flow margin is almost 50/50. It's, it's 18% growth rates. And 18% free cash flow margins. They're neck and neck today in the public markets.

Yeah. So, and I don't think of it as a race, Ray. So, so the, the question that Ray is touching on is, well, wait a minute, you're adding up 2 things to get to 40, and I can get there by adding 40 plus 0 or adding 0 to 40, right? Or I could add 100 to, you know, -60. So, so, so are all Rule of 40 scores the same? Uh, and the answer is no. Which leads to the point I call Rule of 40 composition, which is if you're getting to 40, how are you getting there? Ray is saying that the median of 36 today, people are coming in at 18, 18. And I would say in general, for people who are hitting Rule of 40 on the nose, the median is 20, 20. So, we have adapted and this was totally organic. The formula never said this. The formula was never weighted in any way. Companies kind of organically drifted to what I'm going to call the 20/20 profile on Rule of 40. So that's all true. But now let's go talk about the Rule of 60. One of the obvious questions is, are they going to drift to a 20/40 profile or a 30/30 profile? And we're not going to cover that deeply in the episode. Although in my blog post on this, which we've not talked about, I wrote an article for Topline, the newsletter from Pavilion, on this topic. And I did a model in there and I had the company running on a 20/40 profile, which was not to suggest I think that's the only profile or the right profile. It was just that you have to pick something for an example. If I had to guess, Ray, I think if people strive to and hit Rule of 60, they're probably more on the 30/30 profile. But let's talk more now about why people are moving to the Rule of 60. Like, if you just went to a PE conference today and walked in, and said, is rule of 40 enough? I think most people would say no. And if you said, hey, what should it be, folks? They'd say rule of 60. And the reason for that is really important. But before we go into the reason, Ray, do you have any comments on kind of that premise?

No, I totally agree with that. And I think what you did in the Top Line article— so I do recommend people to do a search for that— it really talked about companies that have been acquired at a certain level of multiples. And now if there's multiple compression, why the rule of 60 becomes so important, but I want you to dive into that.

Yeah. So specifically the example, and this is the example that explains mathematically why the rule of 60 is not going away, why it's not a flash in the pan, while it's not, it's not like board members who asked you about PLG 2 years ago and then forgot they asked, or ABM or some other fad, because look, I've been an operator and Sometimes the board asks for fads and sometimes they ask for stuff that they're serious about. And in many ways, unfortunately, on this one, I think they're serious. And the reason they're serious, as the spreadsheet in that example shows, is the math of the deal falls apart. If I buy you at 30 times EBITDA and then run my normal 4 to 6 year timeframe, and I get you up to a Rule of 40 score on a 2020 profile, You know, if, if, if I buy you at 15 times EBITDA and I can sell you at 15 times EBITDA, all the math works. However, if I buy you at 30 times EBITDA and then need to sell you at 15 times EBITDA, then I need you to be at Rule of 60. And the difference is basically, if I keep you on a Rule of 40 trajectory, you end up being a 1.1x return on investment. And if I can get you to a Rule of 60 trajectory, become a 3x, 3.1x return on investment. And that's what that spreadsheet shows. And the reason I think it's so important, Ray, is people need to understand they're not going away. Like, the math of the deal breaks if a PE guy sponsors a transaction and sells it 5 years later for 1.1x return on the equity. Like, their career is done, right? Uh, they need— and if they sell it for 3x, it's like, hey, good job, buddy, kind of a stand-up double. You know, for, for PE. Thoughts?

Yeah. Well, one of the things we talked about at the very beginning of today's show was about covenants. And a lot of times these PE firms, when they're acquiring a SaaS company, right, they get leveraged, they issue debt. And let's say in your spreadsheet you had the company valuation like $180 million and they have $90 million of debt. That debt needs to be covered by the free cash flow margin. So that's something else that's very important. And operators out there are going to be holding to a certain level of free cash flow margin or EBITDA because they need to not only get the return on investment, they also need to make sure they're covering their debt.

Yeah, I think I did the math in the article, Ray, that said roughly on a typical PE deal, debt service will end up being 10 to 20% of revenue, 20 being high, 10 being low. Um, I won't do the math here. But yeah, I think one reason the rule of 40 average composition converged to 20/20 instead of, say, 40/0 was you need to pay back the debt. Um, and 40/0 doesn't get the debt paid back. 30/10 barely pays back the debt, right? Might create more value, but 20/20 safely pays back the debt and has a decent growth rate. So I think that's why we drifted to the composition, because we're carrying this debt. But the main point of this part of the episode, Ray, is like, this is not going away. The math of the deal breaks, meaning literally your partner kind of gets fired if they, if they, if they keep you on rule of 40 while multiples get cut in half. You know, all other things being equal, it's a 1.1x return and they fail. That's a failure. Because right, in PE, they They don't get a lot of moonshots to offset the strikeouts, right? They need the deals to come in at 3x, you know? So that's why it's not going away, and that's why they're going to keep asking. And the reason I belabor this is if you treat your board like, oh, they're just asking for this now and they're going to go away, you're going to be wrong. So you need to realize that they're serious about trying to get you to Rule of 60, which should then— all of your energy should immediately then go into, okay, how the heck can we do this? Rather than wasting energy on the fight because you will not win. And believe me, I love to fight boards. I've done it a lot to my detriment sometimes, but only fight when you can win. And I don't think you're going to win this one. So, so the energy should go into, yikes, we need to get to Rule of 60. How in the world are we going to do that?

Yeah. And one of the things I liked about the article you wrote, you had 12 ideas of how to do it for the operators out there. Because a couple other things about this is, you know, if you're a SaaS company, your customer acquisition costs have been going up, not down over the last 2 to 3 years. So you need to look for efficiency opportunities in your OpEx. At the same time, if you're integrating some AI, your gross profit may be coming under a little bit of pressure also. So you need to really think out of the box and creative to get to that rule of 60. If, especially if you're PE controlled.

Yeah. Because by the way, I mean, if we didn't have to make things hard enough, right? Like just imagine AI wasn't happening and we said, okay, get yourself from rule of 40 to rule of 60. That's no cakewalk by itself. And now it's like, oh, and by the way, can you please reinvent the product for AI while you're doing that? And by the way, if you succeed and build a great AI product and sell a lot of it, That's going to impact your gross margins quite negatively. So, there is nothing easy about this assignment. But I just want people to know what they're signed up for because they're— in this particular case, I don't think candy-coating it helps anybody. Because you have to make some hard decisions like, let's get out of this business, or let's shut down this business unit, or our strategy won't work. We need to buy 3 companies, right? You're going to need to do fairly radical things.

Yeah.

And, you know, people tend to only do that when their back's against the wall. And right now, as Ray was summarizing, you got to figure out how to get from R40 to R60. You got to reinvent your product for AI. And if you succeed at that, then you need to be ready for working in a reduced gross margin environment.

Yeah. And Dave, you know, we're talking about this is operating reality that we're going to be facing in the SaaS industry. I mean, right now, if you look at The public SaaS companies, only a handful have a rule of 60. Companies like Palantir, Veeva, Rubrik, right? So just a handful. And then there's 9 more that have rule of 50. So 50 to 59. So it's pretty elite, but you need to deal with the reality that you're going to be asked to probably get there.

Yeah. I mean, it's even, it's even more than that, Ray. I recently got to sit in on a kind of all-hands meeting. Between one of the big-name owners of one of the big-name PE firms and a portfolio company. It was great to be in that meeting, kind of fly on the wall. And the owner basically said, you know, we're actually pushing for Rule of 70 because I got some pushback on my blog post here on my Top Line article. People are like, do you think it's going to be easy to do this? It's like, hey, man, read the post. I never said it was going to be easy. I said we had to do it, not that it was going to be easy. So first, I do think it's quite hard. And then second, you know, just as I'm getting used to telling people, hey, bad news, you have to shoot for rule of 60, I got one of the most powerful people in software PE going, well, really 60 may not be enough. You know, we should be going for 70.

Well, all I can say, Dave, is welcome to the brave new world of SaaS, my friend. Yeah.

Yeah. There's nothing easy about this. And I think, you know, that's the real Exciting things happen to me when your back's against the wall because when things are going generally well, you tend to make generally incremental change. And now is not really a time for incremental change. And that's the first big message. And then second, Ray, I do offer up those 12 tips in the Topline article. And I'm just going to quickly run through them just for people who don't have time to read the article. So, one, My advice is, one, ignore the macro whiplash. Macro whiplash. Don't spend all day reading about AI doom and gloom or watching stocks go up and down. You don't have time for it. 2, reframe your job around efficiency, right? Like, I ran a big marketing team. I was proud of how many people I had and how much budget I had. You can't think of that way anymore. You got to think about how much ARR you're generating per marketing dollar, how much ARR per salesperson you're generating. Third, make sure the efficiency burden is shared equally. Because in a lot of these companies, you got a product-oriented founder who doesn't want to touch product. Maybe you got a tough CFO who doesn't want to cut finance. Well, there's not a lot of places, you know, not a lot of other places to go, Ray. And you could end up dumping most of this burden on, you know, sales and marketing or SG&A or sales marketing, basically. So, and you got to fight to make sure you win that battle. And then finally, I'm not going to read all 12, Ray, but I think number 6 was important. Do heretical things. This is back to your backs against the wall. Example, maybe your company SEs always did demos. Well, maybe reps start doing demos. And that would have been heresy 3 years ago, not heresy now. Or if it is heresy now, you have the right to say it because we got to figure out how to get 15 points out of our sales and marketing costs. I had a couple other ones, leverage channel, use AI for real work, do peer networking, which I think is super important. But anyway, back to you, Ray.

Yeah, the one thing I would just say is for those who want to see how companies are performing against the Rule of 40, Rule of 50, Rule of 60, Cloud of Judgment, great newsletter from Jamin Baal, and the MareTech site, they have all this information so you can see what leading companies who are in the public markets are doing.

And just as a reminder, the 90th percentile today I think is 56 for a Rule of 40 score. So it's not like everybody's doing it. Let's go figure out what everybody's doing. Right. It's no, the best of the best are barely doing it and we need to figure out how to do it anyway. So that's about it on my end, Ray. Did you have anything else for today?

Just remember what Wayne Gretzky said. The reason he was such a great hockey player is he skated to where the puck was going, not where it was. And Rule of 60 is where the puck is going.

Ooh, nice ending.

Okay. Bye-bye now.

Bye. The Metrics Brothers AI, SaaS, and More is a production of The Metrics Brothers Growth and CAC and a member of the Benchmarkit Podcast Network. By accessing this podcast, you acknowledge that the Metrics Brothers make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided or the humor content of the jokes told. Ray? Information, opinions, and recommendations presented are, according to our spouses, probably wrong and provided for information purposes only. This podcast should not be considered professional or, for that matter, unprofessional advice. We disclaim any and all liability for any direct, indirect, indirect, misdirect, incidental, special, ordinary, consequential, inconsequential, or other damages arising out of any use of, or God help you, reliance upon the information presented here. Ray Grothreich is based in New York City and available on X @rayreich. Dave Kellogg is based in Silicon Valley and available on X @kelblog. Schedectady, which is French for unspellable, is not our actual production location. Thanks for listening.