The SaaS Midlife Crisis

Among SaaS companies there is a popular metric used to judge the vitality of the business. The “Rule of 40” says that the sum of the company’s growth rate and its free cash flow rate should be 40 or higher. Industry watchers, boards, and management teams like distilling performance into this number, but as McKinsey has found, only about 1/3 of SaaS companies maintain this ratio over time. The Rule of 40 often signifies a midlife crisis for SaaS companies as their early life growth rates decline.

INSIGHT: Of course, one number doesn’t describe the full health or prospects of a company any more than reaching the age of 40 defines a necessary decline in us. But it does signal the need to look at things in new ways. For the SaaS business that means constantly finding new sources of growth, higher customer retention, new efficiencies, and price optimization. For us, it just means that buying a new sports car won’t solve the problem. Mid-life crises of both kinds require fresh efforts to grow and improve, not diversions.

Bill Haines, Partner