First Chicago Method
Encyclopedia
The First Chicago Method or Venture Capital Method is a context specific approach used by venture capital
and private equity
investors that combines elements of both a multiples-based valuation
and a discounted cash flow
(DCF) valuation approach.
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. Most often this methodology will involve the construction of:
The method is used particularly in the valuation of 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.
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. Indeed, professionally performed business appraisals go further and use a set of methods under all three approaches to business valuation.
, the predecessor of private equity
firms Madison Dearborn Partners and GTCR
.
where investors project outcomes for portfolios of private equity investments under various scenarios.
Venture capital
Venture capital is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as...
and private equity
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
investors that combines elements of both a multiples-based valuation
Valuation using multiples
Valuation using multiples is a method for determining the current value of a company by examining and comparing the financial ratios of relevant peer groups, also often described as comparable company analysis . The most widely used multiple is the price-earnings ratio of stocks in a similar...
and a discounted cash flow
Discounted cash flow
In finance, discounted cash flow analysis is a method of valuing a project, company, or asset using the concepts of the time value of money...
(DCF) valuation approach.
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. Most often this methodology will involve the construction of:
- An "upside case" or "best case scenario"
- A "base case"
- A "downside" or "worst case scenario"
The method is used particularly in the valuation of 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.
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. Indeed, professionally performed business appraisals go further and use a set of methods under all three approaches to business valuation.
Origins
The First Chicago Method was first developed and consequently named for First Chicago Corporation Venture CapitalFirst Chicago Bank
First Chicago Bank was a Chicago-based retail and commercial bank tracing its roots back to 1863. Over the years, the bank operated under several names including The First National Bank of Chicago and First Chicago NBD...
, the predecessor of private equity
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
firms Madison Dearborn Partners and GTCR
GTCR
GTCR LLC is a private equity firm focused on leveraged buyout, leveraged recapitalization, growth capital and rollup transactions. As of 2008, it manages more than $8 billion in equity and mezzanine capital invested in a wide range of companies and industries....
.
Other applications
Variations of the First Chicago Method are employed in a number of markets, including the private equity secondary marketPrivate equity secondary market
In finance, the private equity secondary market refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds....
where investors project outcomes for portfolios of private equity investments under various scenarios.
External links
- First Chicago Method: Alternative Approach to Valuing Innovative Start-Ups in the Context of Venture Capital. Social Science Research NetworkSocial Science Research NetworkThe Social Science Research Network is a website devoted to the rapid dissemination of scholarly research in the social sciences and humanities. SSRN is viewed as particularly strong in the fields of economics, finance, accounting, management, and law. SSRN was founded in 1994 by Michael Jensen ...
.