First Chicago method: Difference between revisions

Revision as of 17:00, 31 May 2018

Revision as of 23:37, 11 July 2018

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{{refimprove|date=December 2008}}

The '''First Chicago Method''' or '''Venture Capital Method''' is a context specific [[business valuation]] approach used by [[venture capital]] and [[private equity]] investors that combines elements of both a [[Valuation using multiples|multiples-based valuation]] and a [[discounted cash flow]] (DCF) valuation approach. <ref>[https://www.venionaire.com/first-chicago-method-valuation/ Venture Valuation - First Chicago Method]. [[Venionaire Capital]].</ref>

The First Chicago Method was first developed by, and consequently named for, the venture capital arm of the [[First Chicago Bank|First Chicago Corporation Venture Capital]] bank, the predecessor of [[private equity]] firms [[Madison Dearborn Partners]] and [[GTCR]].<ref>[https://news.gcase.org/2011/04/01/how-to-value-your-deal-like-an-investor/ How to value your deal like an investor]. [[Global Entrepreneurship Institute]]. December 2007.</ref>

==Method==

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Once these have been constructed, the [[valuation (finance)|valuation]] proceeds as follows.<ref>See, for example, Schumann (2006).</ref>

*First, for each of the three cases, a [[Scenario_planning |scenario specific]], ''internally consistent'' forecast of [[cashflow]]s - see [[Financial_modeling#Accounting| discussion]] under [[Financial modeling]] - is constructed for the years leading up to the assumed [[Divestment#Divestment_for_financial_goals |divestment]] by the private equity investor.

*Next, a divestment price - i.e. a [[Terminal value (finance)|Terminal value]] - is modelled by assuming an [[Terminal_value_(finance)#Exit_Multiple_Approach |exit multiple]] consistent with the scenario in question. (Of course, the divestment may take various forms - see [[Private_equity#Investments_in_private_equity|Investments in private equity]] under [[Private equity]].)

*The cash flows and exit price are then [[present value|discounted]] using the investor’s [[Required rate of return|required return]], and the sum of these is the value of the business under the scenario in question.

*Finally, each of the three scenario-values are multiplied through by a [[probability]] corresponding to each scenario (as estimated by the investor). The value of the investment is then the [[Weighted mean|probability weighted sum]] of the three scenarios.