First Chicago method

<h2 id="method">Method</h2>
<p>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 <a href="/facts/Corporate_finance/ugQCsFBQ">Corporate finance § Quantifying uncertainty</a>. 
Most often this methodology will involve the construction of:
</p>
<ul><li>An "upside case" or "best-case scenario" (often, the <a href="/facts/Business_plan/PmJfIjr3">business plan</a> submitted)</li>
<li>A "base case"</li>
<li>A "downside" or "worst-case scenario"</li></ul>
<p>Once these have been constructed, the <a href="/facts/Valuation_(finance)/ubVtk8RG">valuation</a> proceeds as follows.<a class="footnote-ref" id="fnref:4" href="#fn:4"><sup>4</sup></a> 
</p>
<ol><li>First, for each of the three cases, a <a href="/facts/Scenario_planning/SHMWDWGv">scenario specific</a>, <i>internally consistent</i> forecast of <a href="/facts/Cashflow/TM2tHnlW">cashflows</a>  is constructed for the years leading up to the assumed <a href="/facts/Divestment/QFHuyJk1">divestment</a> by the private equity investor.</li>
<li>Next, a divestment price - i.e. a <a href="/facts/Terminal_value_(finance)/NXRdqxW3">Terminal value</a> - is modelled by assuming an <a href="/facts/Terminal_value_(finance)/NXRdqxW3">exit multiple</a> consistent with the scenario in question. (The divestment may take various forms.)</li>
<li>The cash flows and exit price are then <a href="/facts/Present_value/1Ea8bdC2">discounted</a> using the investor’s <a href="/facts/Required_rate_of_return/pm5a7BYj">required return</a>, and the sum of these is the value of the business under the scenario in question.</li>
<li>Finally, each of the three scenario-values are multiplied through by a <a href="/facts/Probability/fgYvMhwb">probability</a> corresponding to each scenario (as estimated by the investor). The value of the investment is then the <a href="/facts/Weighted_mean/VHyJfPxb">probability weighted sum</a> of the three scenarios.</li></ol>
<h2 id="use">Use</h2>
<p>The method is used particularly in the valuation of <a href="/facts/Growth_company/ol3jQvJ9">growth companies</a> which often do not have historical financial results that can be used for meaningful <a href="/facts/Comparable_company_analysis/24jVMdHd">comparable company analysis</a>.  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.  
</p><p>Often the First Chicago method may be preferable to a discounted cash flow taken alone. This is because such income-based business value assessment may lack the support generally observable in the market place. Professionally performed business appraisals go further and use a set of methods under all three approaches to business valuation.<a class="footnote-ref" id="fnref:5" href="#fn:5"><sup>5</sup></a>
</p><p>Variations of the First Chicago method are employed in a number of markets, including the <a href="/facts/Private_equity_secondary_market/XX4GMIhC">private equity secondary market</a> where investors project outcomes for portfolios of private equity investments under various scenarios.
</p>
<h2 id="see-also">See also</h2>
<ul><li><a href="/facts/RNPV/pY6Lt5WK">rNPV</a>: cash flows, as opposed to scenarios, are probability-weighted.</li>
<li><a href="/facts/Expected_commercial_value/eb2FdtD6">Expected commercial value</a></li>
<li><a href="/facts/Valuation_using_discounted_cash_flows/AWrlU3fM">Valuation using discounted cash flows #Determine equity value</a></li></ul>
<h2 id="notes">Notes</h2>

<ul><li>Ann-Kristin Achleitner and  Eva Lutz. (2008). <a href="http://ssrn.com/abstract=1133004">First Chicago Method: Alternative Approach to Valuing Innovative Start-Ups in the Context of Venture Capital</a>, <a href="/facts/Social_Science_Research_Network/njd3WRzR">Social Science Research Network</a> Accepted Paper Series.</li>
<li>James L. Plummer. (1997). <a href="https://web.archive.org/web/20121224010823/http://www.qedresearch.biz/Lit%20pub%205.pdf">A Primer on Venture Capital Financial Calculations</a>, 23rd Annual Venture Capital Institute.</li>
<li>C.P. Schumann (2006). <a href="https://web.archive.org/web/20120417052406/http://www.cpschumannco.com/storeimages/MonteCarloArticle.pdf">Improving Certainty in Valuations using the Discounted Cash Flow Method</a>, <i>Valuation Strategies Magazine</i>, September/October 2006.</li></ul>

<h2 id="references">References</h2>

<ol>
<li id="fn:1"><p>Venture Valuation - First Chicago Method. Venionaire Capital. <a href="https://www.venionaire.com/first-chicago-method-valuation/" target="_blank">https://www.venionaire.com/first-chicago-method-valuation/</a> <a href="#fnref:1" class="footnote-back-ref">↩</a></p></li>
<li id="fn:2"><p>How to value your deal like an investor. Global Entrepreneurship Institute. December 2007. <a href="https://news.gcase.org/2011/04/01/how-to-value-your-deal-like-an-investor/" target="_blank">https://news.gcase.org/2011/04/01/how-to-value-your-deal-like-an-investor/</a> <a href="#fnref:2" class="footnote-back-ref">↩</a></p></li>
<li id="fn:3"><p>William A. Sahlman and Daniel R Scherlis (1987). A Method For Valuing High-Risk, Long-Term Investments: The "Venture Capital Method". 
Harvard Business School (Case Collection, 288-006) <a href="https://www.hbs.edu/faculty/Pages/item.aspx?num=6515" target="_blank">https://www.hbs.edu/faculty/Pages/item.aspx?num=6515</a> <a href="#fnref:3" class="footnote-back-ref">↩</a></p></li>
<li id="fn:4"><p>See, for example, Schumann (2006). <a href="#fnref:4" class="footnote-back-ref">↩</a></p></li>
<li id="fn:5"><p>Business valuation using the Market, Income and Asset Approaches. ValuAdder
 <a href="http://www.valuadder.com/valuationguide/business-valuation-three-approaches.html" target="_blank">http://www.valuadder.com/valuationguide/business-valuation-three-approaches.html</a> <a href="#fnref:5" class="footnote-back-ref">↩</a></p></li>
</ol>

First Chicago method open-in-new

First Chicago method