With the boom of software and AI, everyone wants a piece. Honestly, that instinct isn’t wrong. Several software companies are springing up on a daily basis, and early investors in the right company can win big. In this excitement, a lot of people miss something fundamental. You can not invest in a company without first knowing what that company is actually worth.
*My Practical Experience*
A client came to me excited about an opportunity. A software company had offered him 5% equity for $30,000. When he asked the CEO how they arrived at that price, the answer seemed simple: “Our company is valued at roughly ₦500 million.” No further explanation, just a number, confidently stated.
The company had already started business operations and had developed a fair number of subscribers and users, and my client was ready to move forward. He brought the deal to me for legal review, but the real work turned out to be financial.
Two major Red Flags were identified.
*The First Red Flag: The Numbers Didn’t Match Up*
Before we got to whether ₦500 million was a fair valuation, something simpler stood out. The ₦500m wasn’t consistent with the offer itself.
$30,000 for 5% equity implies a full company valuation of $600,000. At current exchange rates, that’s roughly ₦840 million, a figure significantly more than the ₦500 million the CEO had quoted.
This is a common flaw. Founders often quote a valuation figure they’ve heard, read, or simply want to believe, without it being tied to any actual calculation. But it doesn’t end there.
*The Second Red Flag: Numbers Alone Mean Nothing*
A company’s valuation isn’t something a founder gets to simply declare. Especially for a software company where valuation is tied directly to how the company actually makes money and not how big its dreams are.
When I reviewed the business, I found that it was a subscription-based software product, generating roughly ₦15 million in annual recurring revenue (ARR). This single number matters more than almost anything else the CEO said.
Applying the Real Standard Internationally, early-stage recurring-revenue software businesses are typically valued using an ARR multiple, in this case (3x to 6x ARR range), with the higher end reserved for businesses showing strong growth and client retention.
Using a reasonably generous multiple of 6x, the real company valuation is merely ₦90,000,000. The calculation is the Annual Recurring Revenue of ₦15,000,000 × 6 (ARR multiple) = ₦90,000,000.
Now, valuation isn’t only about revenue. Certain factors can genuinely justify a premium above the base range. Factors such as;
Is the software service fully built and functional with the use of AI and no human interference? How strong is customer retention? Is the business profitable, or showing efficient, sustainable growth? Importantly, a premium multiple is earned by a combination of these factors performing well together.
Assuming this company genuinely scored well across all three in strong retention, healthy margins, and a real AI advantage, the multiple could stretch toward the top of a realistic range, around 8x: ₦15,000,000 × 8 = ₦120,000,000.
Even in the most generous, best-case scenario, this company was worth roughly ₦120 million. Compare that to the ₦500 million the CEO quoted or the ₦840 million implied by his offer terms.
*Which meant that if the company was operating at the very best case, $30,000 wasn’t buying 5% of the company but 35%. That’s an additional 30% in equity.*
Proceeding on the CEO’s word alone would have been a significant investment flaw.
*CONCLUSION*
This experience isn’t unique. It happens every day to investors, to founders’ friends and family, to anyone who trusts a confident pitch. Interestingly, this doesn’t apply to Software companies alone. There are clear metrics that must be studied in the valuation of businesses in different sectors. A good deal can survive scrutiny. A bad one rarely does.
*David G. Enang Esq.*
Legal Practitioner
