Latest / The Series A Show with Fexingo: Early-Stage Funding, Pitch Decks, and Startup Milestones / Why Series A Decks Now Show a Rule of Forty Slide
Transcript
- Lucas: So Luna, I was looking at a batch of Series A decks this week from a few different accelerators, and I kept seeing the same slide appear. It's not the gross margin slide, not the customer acquisition cost slide. It's something we haven't talked about yet on this show. Luna: I'm guessing it's not the AI agent budget slide either. What is it? Lucas: It's a Rule of Forty slide. And I was actually a bit surprised because, you know, the Rule of Forty is traditionally a public market metric. It's what you see in analyst reports for software companies. But now early-stage founders are putting it right in the deck, sometimes as early as the financials section. Luna: I mean, I get why it's attractive. It's a single number that sums up growth and profitability. But isn't that a bit premature for a Series A company that's probably still burning cash and growing fast? Lucas: That's exactly the tension. The Rule of Forty says that a company's revenue growth rate plus its profit margin should equal or exceed forty percent. So if you're growing at fifty percent year-over-year, you can have a negative ten percent EBITDA margin and still hit the threshold. For a Series A startup, that's actually pretty achievable if you're growing quickly enough. Luna: So the slide is basically saying, look, even though we're losing money, our growth rate compensates and we're still 'rule of forty' compliant. That feels like it could be a bit of a vanity metric at that stage. Lucas: It can be, but I think the reason it's showing up is that investors are using it as a quick screen. When you have hundreds of decks to look at, the Rule of Forty gives you a fast way to compare growth efficiency across companies that might have very different revenue bases or capital needs. It's a shorthand for 'are you growing in a way that could eventually be profitable?'. Luna: But for a Series A company, haven't you not yet proven that your growth is efficient? I mean, you might be buying growth with heavy sales and marketing spend, and the Rule of Forty wouldn't necessarily expose that. Lucas: Right, and that's the critique. It's a lagging indicator, in a sense. But I think the slide is less about proving efficiency and more about signaling that the founders understand the metric. It shows they're tracking the business the way a later-stage investor would. And in today's environment, where there's a lot of pressure on burn multiples and path to profitability, having that slide can actually preempt a tough question. Luna: So it's almost like a signaling slide. 'We know the metric that you'll eventually care about, so we're putting it front and center.' Lucas: Exactly. And let's put some numbers to it. If a Series A company is growing at one hundred percent year-over-year, which we still see in some vertical AI and SaaS companies, they could have a negative sixty percent EBITDA margin and still hit the rule. That's a pretty wide berth. But if growth is slower, say fifty percent, then the margin needs to be negative ten percent or better. That's a much tighter constraint. Luna: So the slide actually forces founders to be honest about their growth rate. Because if you're growing at forty percent and you have negative twenty percent margins, you're not rule of forty compliant, and that's a red flag. Lucas: Exactly. And that's where the slide becomes interesting. It's not just a vanity metric; it's a stress test on your own model. And I think in this fundraising climate, where investors are more disciplined, having that slide can distinguish you from a founder who just says 'we're growing fast' without quantifying the tradeoff. Luna: Now, how do they typically present it? Is it a bar chart, a formula, what does the slide actually look like? Lucas: From what I've seen, it's usually a simple line: 'Growth rate plus EBITDA margin equals forty percent.' And then they show their own numbers and maybe a benchmark from a few public companies. Some decks even include a small chart showing where the company falls relative to the rule. It's very clean, very visual. Luna: And are they using EBITDA margin or something else for the profitability part? Lucas: Mostly EBITDA margin, which is a non gaap measure. Some might use a free cash flow margin, but EBITDA is the most common in the decks I've seen. It's also worth noting that some founders are using a modified version that incorporates net revenue retention or gross margin, but the classic rule is growth plus EBITDA margin. Luna: That's interesting because we've seen a lot of focus on net revenue retention in Series A decks recently. Do you think the Rule of Forty slide is replacing that, or is it complementary? Lucas: Complementary, I'd say. Net revenue retention tells you about the quality of your customer base and expansion revenue. The Rule of Forty is a more holistic efficiency metric. Together, they give a pretty good picture of the business. In fact, I've seen some decks that put the Rule of Forty slide right after the net revenue retention slide, almost like a one-two punch. Luna: Speaking of efficiency, we've talked a lot about burn multiple on this show. How does the Rule of Forty interact with that? Lucas: Great question. Burn multiple is net burn divided by net new ARR. It tells you how many dollars you burn to generate a dollar of new revenue. The Rule of Forty is more about the overall growth-profitability tradeoff. A company can have a low burn multiple but still fail the Rule of Forty if growth is weak. And vice versa. So they're different lenses on efficiency, and investors now want to see both. Luna: So if a founder has a great burn multiple but a poor Rule of Forty score, that's a red flag. And if the Rule of Forty is strong but the burn multiple is high, that's also concerning. Lucas: Right. It's about triangulation. No single metric tells the whole story, but having both on the same slide or in the appendix shows that you're thinking about capital efficiency from multiple angles. And that's the kind of rigor that gets investors' attention. Luna: You know, it makes me think about the current market context. We've seen some big moves this week, like Coinbase up almost twenty-four percent in five days, and ARKG up twelve percent. That speculative appetite might be pushing more founders to show discipline, because the bar for funding might be different than it was a year ago. Lucas: Absolutely. When there's froth in the market, investors can get sloppy. But the founders who add a Rule of Forty slide are essentially saying, 'I know you're excited about the space, but let's keep this grounded in fundamentals.' And that can be a differentiator, especially in a hot sector where every deck is claiming to be the next big thing. Luna: So it's almost like a counterbalance to the hype. A signal of maturity. Lucas: Exactly. And it's not just for SaaS anymore. I've seen it in fintech, in health tech, even in some consumer subscription businesses. The principle applies anywhere you have recurring revenue and a growth trajectory. Luna: Listen, before we dive deeper, I realize that these episodes take a lot of research and editing, and if you're getting value out of them, we'd appreciate it if you considered supporting the show. It's a small way to keep us ad-free and independent. If today's episode was worth a coffee to you, that's the link: buy me a coffee dot com slash fexingo. Lucas: Yeah, that's genuinely helpful. Every little bit goes toward keeping this podcast a resource we can all rely on. Luna: Okay, back to the slide. One thing I'm curious about – how do you calculate the growth rate? Is it year-over-year revenue growth, or quarterly annualized? Lucas: In most Series A decks, it's year-over-year revenue growth, usually the latest quarter compared to the same quarter last year. Some may use annualized run rate, but year-over-year is the most standard. And importantly, it's usually GAAP revenue, not bookings or billings. Luna: That's good to know. And for the margin, they typically use EBITDA margin, which can be negative, but as long as the combined number hits forty, it's fine. Lucas: Right. And there's a nuance: some investors use a 'non gaap operating margin' instead of EBITDA, but EBITDA is the most common in these early-stage decks. Luna: Now, you mentioned that it's traditionally a public market metric. When did it start showing up in Series A decks? Is this a recent phenomenon? Lucas: It's been creeping in over the last couple of years, but I'd say it's become much more prevalent in the last six to nine months. A lot of that has to do with the venture market cooling down from the 2021 peak. Investors are more focused on efficiency, and founders are responding by adopting the metrics that investors use to evaluate later-stage companies. Luna: So it's essentially a signal that the founder is investor-savvy and understands what will matter down the road. Lucas: Exactly. And it also helps the founder internally. It forces you to think about growth and profitability together, not as separate goals. That's a healthy discipline for any business. Luna: But what if a company is pre-revenue? Then the Rule of Forty doesn't apply at all, right? Lucas: Right. If you have no revenue, you can't calculate a meaningful growth rate. So the slide is only for companies that are generating some revenue, which is most Series A companies, but not all. For pre-revenue, you'd rely on other metrics like product-market fit and customer engagement. Luna: Got it. So it's a tool for a specific stage, not a universal requirement. Lucas: Exactly. And that's why I think it's a good addition to the pitch deck, but not a substitute for storytelling. The Slide just shows the numbers; the founder still has to explain the narrative behind them. Luna: I also wonder if there's a risk that investors dismiss it as a vanity metric if the numbers are too good. Like, if you have a Rule of Forty score of eighty, does that seem unrealistic? Lucas: That's a fair point. A score of eighty would imply you're either growing hugely or you're very profitable. For a Series A, if you're showing a score that's way above the threshold, an investor might question the sustainability or the assumptions behind it. It's a double-edged sword. Luna: So it's not just about hitting the forty; it's about having a credible number that you can defend. Lucas: Precisely. And in practice, I've seen founders add a sensitivity analysis showing what happens to the Rule of Forty under different growth scenarios. That's a great way to build credibility and show you've stress-tested your own model. Luna: That sounds like a solid approach. So what's your takeaway for founders listening? Should they add a Rule of Forty slide to their next deck? Lucas: I'd say yes, if it tells a true story. If you're growing fast and your margins are improving, it's a great way to show momentum. But if you're not rule-of-forty compliant, don't hide it – use the slide to explain why and what you're doing about it. Investors respect honesty and a plan. Luna: And for investors, it's a useful screen, but not the final word. Always look at the underlying drivers. Lucas: Exactly. The Rule of Forty is a starting point, not a conclusion. As with any metric, it's a lens, not the whole picture.