A good rule of thumb developed by the VC and Private Equity community is the Rule of 40. This blunt instrument is used by investment professionals to evaluate both high-growth and even very well-established companies. The Rule of 40 is easy to calculate, you can do it immediately for your business. Simply add a company’s growth rate from the last two fiscal years to its profitability for the last fiscal year.

This rule speaks volumes to the health of your company. If you’re a startup and are growing at 40-50% YoY, it is expected that you are plowing all of your profits back into your business. If you’re an established business and growing at 10% year over year, but have 40% margin in your EBITDA, you’re doing pretty well.

Do Private Equity and Strategics immediately pass on any opportunity that does not at that moment fit into the Rule of 40? Nobody’s perfect. Certainly, many of our clients cannot yet clear this high bar on their own. Remember, a buyer is looking at you from a perspective of future earnings and profitability – so if there is a compelling story of how you’ll grow into this metric, especially leveraging the buyer’s unique capabilities, you can quickly build a thesis of why an acquirer would want to move quickly.

Also note that not all “revenues” are created equally – I urge everyone to download our Quality of Revenue whitepaper. Certainly, the buyer will prefer if all 40% of your growth or margins come from revenue that is recurring, or at the very least repeatable.