Concept
The First Chicago Method or Venture Capital Method is a business valuation 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. The First Chicago Method was first developed by, and consequently named for, the venture capital arm of the First Chicago bank, the predecessor of private equity firms Madison Dearborn Partners and GTCR. It was first discussed academically in 1987. 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 . Most often this methodology will involve the construction of: An "upside case" or "best-case scenario" (often, the business plan submitted) A "base case" A "downside" or "worst-case scenario." Once these have been constructed, the valuation proceeds as follows. First, for each of the three cases, a scenario specific, internally consistent forecast of cashflows - see discussion under Financial modeling - is constructed for the years leading up to the assumed divestment by the private equity investor. Next, a divestment price - i.e. a Terminal value - is modelled by assuming an exit multiple consistent with the scenario in question. (Of course, the divestment may take various forms - see Private equity #Investments in private equity.) The cash flows and exit price are then discounted using the investor’s 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 probability weighted sum of the three scenarios. 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.