SaaS Finance, Part 4: Rules of Thumb
The shorthand metrics that investors use to quickly assess whether a SaaS business is worth a deeper look — and the hierarchy of what matters most depending on who's across the table.
Efficiency Metrics
Rule of 40
Combined growth rate and profitability should exceed 40%.
Formula: Rule of 40 = Revenue Growth Rate % + EBITDA Margin %
| Growth | EBITDA Margin | Score |
|---|---|---|
| 50% | -10% | 40 ✓ |
| 30% | 10% | 40 ✓ |
| 20% | 20% | 40 ✓ |
| 25% | 5% | 30 ✗ |
The Rule of 40 is a sanity check, not a target. A company at 60% growth and -30% margin (score: 30) may be making the right tradeoff if unit economics are strong and the market window is closing. A company at 10% growth and 30% margin (score: 40) technically passes but may be a lifestyle business with no growth catalyst.
Magic Number
Efficiency of S&M spend in generating new ARR.
Formula: Magic Number = Net New ARR (this quarter) / S&M Spend (last quarter)
The one-quarter lag is deliberate — marketing spend takes time to convert. Using same-quarter spend understates efficiency for long-cycle sales.
| Magic Number | Assessment |
|---|---|
| Below 0.5 | Inefficient — spending more than you're getting back |
| 0.5-0.75 | Acceptable |
| 0.75-1.0 | Good |
| Above 1.0 | Excellent — consider investing more aggressively |
Burn Multiple
How much you burn per dollar of net new ARR. The inverse of the Magic Number applied to total burn, not just S&M.
Formula: Burn Multiple = Net Burn / Net New ARR
| Burn Multiple | Assessment |
|---|---|
| Below 1x | Excellent |
| 1-1.5x | Good |
| 1.5-2x | Acceptable |
| Above 2x | Concerning — burning cash faster than growing |
A burn multiple above 2x means you're spending $2+ for every $1 of new ARR. At that rate, you need significant acceleration in either growth efficiency or margin expansion to reach profitability before running out of cash.
What PE Investors Focus On
PE and growth equity investors evaluate SaaS businesses on a specific hierarchy. The order matters — they screen on the first few, then dig into the rest.
Primary Valuation Metrics
- ARR — Revenue scale. "Is this big enough to be interesting?"
- ARR Growth — Momentum. "Is this accelerating or decelerating?"
- EBITDA Margin — Profitability. "Can this business generate cash?"
- Rule of 40 — Combined health. "Is the growth/profit tradeoff reasonable?"
- NRR — Customer quality. "Is the installed base growing on its own?"
Unit Economics (Deal Feasibility)
Once the top-line metrics pass the screen, investors dig into whether the business model fundamentally works:
- Gross Margin — Delivery efficiency. "Can they serve customers without bleeding money?"
- Contribution Margin — Unit profitability. "Does each incremental customer contribute positive dollars?"
- LTV:CAC — Return on acquisition. 3:1+ is the threshold. Below that, growth destroys value.
- Payback Period — Cash efficiency. Under 18 months is the target. Over 24 months is a red flag for capital intensity.
Risk Factors
What makes investors walk away, even when the top-line story looks good:
- Churn Rate — Customer stickiness. Monthly churn above 3% for mid-market (or 1% for enterprise) signals product or market issues.
- Customer Concentration — Revenue dependence. If the top 10 customers represent 40%+ of revenue, losing one is catastrophic.
- NRR below 100% — Shrinking base. This means the installed base is contracting — new sales are just backfilling churn.
- Payback above 24 months — Capital intensity. Long payback periods mean the business needs continuous funding to grow, which compresses returns.