Allied Advisers updated Brief Analysis (SaaS): Rule of 40 report for 1H2023, shows that software companies which exceed Rule of 40 continue to trade at significant premium valuations compared to companies that fall below Rule of 40. In today’s challenging market conditions, we are seeing clients and prospects who meet or exceed Rule of 40 are getting multiple bids at valuation multiples that exceeds their peers who don’t.
Rule of 40 continues to become more fashionable in today’s capital constrained environment and is a useful tool for founders, management and investors to keep in mind as they build their companies for optimal financing and exit valuation.
The rule of 40 is an index, not a ratio, and should not have % next to it. It is not actually the sum of percentages (which would require that the two rates represent the same quantities or measures), but the sum of the real number representations of two rates. That makes it an index that does not need a notation, only a label. Growth rate is Δrev/Δtime and EBITDA is costs/revenue, both of which can be expressed as a ratio and can thereby be expressed as a percent. The formula for rule of 40 cannot be expressed as a ratio, so it is cannot be a percent.