The Rule of 40 is a benchmark for evaluating software businesses: revenue growth % plus free-cash-flow margin % should add up to at least 40.
Same score, different fundamentals. A company growing 30% with a 10% margin scores 40. So does one growing 10% with a 30% margin.
Same Rule of 40, different valuations. Meritech’s data (September 2026) shows that companies with similar Rule of 40 scores can trade at significantly different multiples:
Similar scores, but valuations can differ by more than 2×. In October 2023 the gap was much narrower: 7.7x for growth-led companies versus 6.8x for margin-led ones.
The market is rewarding growth more than margin. The traditional Rule of 40 treats both equally, but Meritech’s regression suggests that when it comes to valuation, +1% of revenue growth is worth roughly +3.8% of FCF margin.
Why are investors favoring growth? AI is fundamentally changing the economics of software, and it’s reshaping both sides of the Rule of 40. Growth is shifting from seat-based revenue to usage, work and outcomes. Margins are shifting from low marginal costs to AI inference costs that scale with usage.
If AI is changing how software grows and makes money, is the Rule of 40 still the right benchmark?
Source: Meritech Capital, Software Pulse (September 2026)
