Introducing the Rule of 25/20/15/10: A Pathway to the Rule of 50!

Once upon a time, in the realm of private software companies, a sage rule known as the Rule of 40 was the gold standard. It dictated that a company's revenue growth rate plus its EBITDA margin should be equal to or greater than 40% (20% revenue growth + 20% EBITDA margins = 40%). This Rule was a guiding star for many SaaS CEOs, illuminating the path to balancing growth and profitability.? However, as the software industry continued to mature, a group of forward-thinking investors began to think, "Why should we be satisfied with R40 when we could aim for more?"? The promise of software business models is you can build something once and sell it as a highly recurring subscription over many years to many customers, implying there should be real operating leverage and inherent profitability in SaaS businesses.

Generating sustained revenue growth is hard; generating sustained profitable revenue growth is even harder.? Companies flush with cash from investors tend to overspend in sales and marketing efforts to artificially drive top line growth.? But when confronted with a slower economy and sluggish fundraising environment, operators need to practice self-sustaining growth.? 15-30% top line growth has become more commonplace in recent years, so to hit the Rule of 50+, entrepreneurs could benefit from a roadmap to manage expenses more thoughtfully.?

If the Rule of 50 is the main course, we’ve ordered a side dish as a companion rule – The Rule of 25/20/15/10.? Now this may sound like a cryptic code from a blockbuster spy movie. Rather, it is actually a clear, straightforward guide for managing expenses. It's like a budgeting GPS, guiding CEOs to reach their destination of higher profitability without blowing their budget on the way.

*25% or less of revenue should be spent on cost of goods sold (COGS). This includes expenses like web hosting, which, left unchecked, can multiply faster than Swifties at a Chiefs game. Also, don't forget the costs of software implementation.

*20% or less should be earmarked for sales and marketing (S&M). This includes everything from sales commissions, marketing expenses, and sales operations costs.

*15% or less to be spent on research and development (R&D). This is where the magic happens! It's like Santa's workshop, but instead of elves, developers are working on exciting new features, maintaining existing products, and even managing offshore teams.

*10% or less to be spent on general and administrative (G&A) expenses. This includes management salaries, office rent and travel expenses.

In essence, the evolution from the Rule of 40 to the Rule of 50+ and the introduction of the Rule of 25/20/15/10 represent a more ambitious, detailed, and fine-tuned approach to balancing growth and profitability. It's not a one-size-fits-all rule, but more of a made-to-measure suit that can be tailored to each company's unique needs.? Indeed, if you are a small company (say under $25m in revenues) and still growing rapidly (say over 40% a year), it’s probably too soon to start optimizing around this rule.? But it’s worth tracking against it even when you’re in hyper-growth mode.

When it comes to growth and profitability, it's not just about reaching the finish line; it's also about enjoying the journey. With the Rule of 50+ and its companion, the Rule of 25/20/15/10, that journey just became much more navigable, so buckle up and enjoy the ride!

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