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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>[http://research.kauffman.org/cwp/appmanager/research/researchDesktop;jsessionid=IaIkfkTdY4dXKNiCWdGg61LY3d2P2Ke79urHnyuu4spdtbYuPfvo!484687239?_nfpb=true&_pageLabel=research_resourceDetail&keep=all&id=1133004&_nfls=false Kauffman Foundation article on The First Chicago Method]. [[Kauffman Foundation]].</ref>
The First Chicago Method was first developed and consequently named for [[First Chicago Bank|First Chicago Corporation Venture Capital]], the predecessor of [[private equity]] firms [[Madison Dearborn Partners]] and [[GTCR]].<ref>[http://blog.gcase.org/archives/216 "How to value your deal like an investor?"]. [[Global Entrepreneurship Institute]]. December 2007.</ref>▼
Rather than completing a valuation of the company, the First Chicago Method takes account of payouts to the holder of specific investments in a company through the holding period under various scenarios; see [[Corporate_finance#Quantifying_uncertainty| Quantifying uncertainty]] under [[Corporate finance]]. Most often this methodology will involve the construction of:▼
==Method==
▲
* An "upside case" or "best case scenario" (often, the [[business plan]] submitted)
* A "base case"
* A "downside" or "worst case scenario"
The [[valuation (finance)|valuation]] proceeds as follows.<ref>See, for example, Schumann (2006).</ref>
First, for each case, 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. [[Terminal value]]{{dn|date=June 2012}} - 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.
==Use==
The method is used particularly in the valuation of [[growth company|growth companies]] which often do not have historical financial results that can be used for meaningful [[comparable company analysis]]. Multiplying actual financial results against a comparable valuation multiple often yields a value for the company that is objectively too low given the prospects for the business.
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Variations of the First Chicago Method are employed in a number of markets, including the [[private equity secondary market]] where investors project outcomes for portfolios of private equity investments under various scenarios.
==External links and references==▼
▲The First Chicago Method was first developed and consequently named for [[First Chicago Bank|First Chicago Corporation Venture Capital]], the predecessor of [[private equity]] firms [[Madison Dearborn Partners]] and [[GTCR]].<ref>[http://blog.gcase.org/archives/216 "How to value your deal like an investor?"]. [[Global Entrepreneurship Institute]]. December 2007.</ref>
'''Notes'''
{{reflist}}
'''Links'''
▲==External links and references==
*Ann-Kristin Achleitner and Eva Lutz. (2008). [http://ssrn.com/abstract=1133004 First Chicago Method: Alternative Approach to Valuing Innovative Start-Ups in the Context of Venture Capital], [[Social Science Research Network]] Accepted Paper Series.
*James L. Plummer. (1997). [http://www.qedresearch.biz/Lit%20pub%205.pdf A Primer on Venture Capital Financial Calculations], 23rd Annual Venture Capital Institute.
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