IS THE “RULE OF 40” STILL TELLING THE TRUTH ABOUT PROFITABLE EUROPEAN SAAS?

Why, at ISAI, we are investigating a new framework for Growth Equity in SaaS in 2026

For the past ten years, one number has shaped the conversation between software company leaders and growth equity investors: 40. Revenue growth + EBITDA (or FCF) margin ≥ 40%. A simple rule, which has become the obligatory checkpoint of any software transaction.

I am not claiming that this rule has become useless. But we are wondering, at ISAI and among several of our peers, whether it is not gradually becoming misleading and whether the leaders of profitable SaaS companies building their strategy around it as a key compass might not be making decisions that run counter to what the transaction market actually values today.

This op-ed does not pretend to deliver a settled truth. It shares the questions we are asking ourselves, the avenues we are exploring, and the provisional framework (which we internally call AICE, for AI Cost & Efficiency) that we are currently testing on new transactions.

One important caveat before we proceed: this op-ed concerns profitable SaaS companies whose business model remains structurally intact. It does not apply to companies directly affected by the so-called "SaaSpocalypse" of early 2026, those whose core proposition is being challenged by direct AI-native alternatives. We intend to return to that subject in a separate piece.

Does the Rule of 40 still separate good companies from the rest?

According to SaaS Capital’s 2025 analysis, Rule of 40 scores among private SaaS companies have declined across nearly every ARR bracket over the past two years, essentially because growth is slowing everywhere. A significant majority of software vendors no longer pass the test.

Should we conclude that c. three quarters of our universe has become un-investable? Obviously not. However, one can legitimately wonder whether such rule still separates the strong performers from the rest.

Do growth and profitability really carry the same weight?

Bessemer, which had nonetheless helped popularize the Rule of 40, published as early as 2024 an argument we find hard to ignore with their Rule of X by which revenue growth should be weighted 2 to 3 times more than EBITDA margin.

While we observe, on the recent transactions we are tracking in France and across Europe, that the best multiples are consistently going to companies with strong growth and high retention, such bias is not strictly reflected in the initial Rule of 40.

What does AI really do to a software company’s P&L?

At the moment, the debate focuses almost exclusively on the gross margin compression linked to AI inference costs. Is this concern well-founded? While only nascent at this stage, for a traditional SaaS company adding AI on top of an existing product, the pressure on gross margin can indeed be significant (up to 15-20% downward according to early datapoints).

But is that enough to conclude that AI is destroying the SaaS model? We seriously doubt it. And it is precisely this doubt that structures our AICE thinking.

Because the very same AI that erodes gross margin does something very different on the S&M and R&D side. In NVIDIA’s 2026 survey, 87% of executives report that AI has reduced their annual costs, and the productivity gains observed appear robust enough to durably reshape the structure of the P&L.

This observation is, in our view, at the heart of the matter: is AI shifting margin from COGS to OpEx, with a net effect that is potentially neutral or even positive for well-managed companies? Our current working hypothesis is that yes but we remain cautious, and that is what we are trying to test transaction by transaction.

A third element adds to this equation: the pricing power window. IT buyers may still accept, for the next 18 to 24 months, that AI justifies price increases, before it becomes expected as part of the base price. The software vendors that manage to capture this window may well positively impact their margin trajectory over the next two to three years.

Our AICE framework adresses 4 questions

Unlike the Rule of 40, AICE is not a mathematical formula, and we do not believe it should become one. It is a discipline of four questions that we now impose on ourselves for every new transaction, and that we systematically address to the founders we partner with:

First question: what is the gross margin trajectory post-AI absorption?

Second question: what is the plan for productivity gains across OpEx? Which functions will be augmented as a priority, on what timeline, with what measurable impact?

Third question: what is the pricing power capacity within 24 months? Which modules can be monetized separately? What sustainable price increases can be applied to the installed base?

Fourth question: what is the net EBITDA outcome at 24-36 months?

We do not claim that this framework is the definitive answer. We do believe that it asks the right questions, which is already a lot at a moment when the market is in transition.

For the founders reading us

Should you continue to trade 3 points of growth against 5 points of EBITDA margin in order to optimize a Rule of 40 score? The available data suggests not. The opposite trade-off, i.e. accepting a temporarily lower EBITDA margin in order to defend growth, may well be more value-creating over time.

Should you fear a temporary compression of gross margin linked to AI? First of all, such compression shall be carefully monitored and understood and it may not be a problem in the end if a plan of AI productivity gains can offset the dilution, combined with a pricing strategy that captures part of the value created for your customers. This three-variable equation (inference cost, internal productivity, pricing power) strikes us as the one that truly matters.

In conclusion

The Rule of 40 has rendered immense service to our industry. But like any heuristic, it eventually ends up obscuring the reality it was meant to illuminate.

Our provisional conviction is that we are entering an era in which growth matters more than ever, where the quality of that growth matters more than its volume, and where AI is rewriting the margin equation not by destroying it, but by shifting it within the P&L.

At ISAI, we are moving forward with this AICE thinking, open to discussion, to disagreement, and above all to dialogue with the founders who are asking themselves the same questions we are.