First Chicago Method for Startup Valuation

The First Chicago Method is a business valuation technique that blends elements of both qualitative and quantitative analysis. Developed initially by the venture capital arm of the First Chicago Bank, this method has garnered significant attention in the realms of private equity and venture capital investment. This is because it provides a structured way to deal with the uncertainty inherent in valuing early-stage companies with unpredictable futures. The First Chicago Method operates by creating a probability-weighted average of multiple valuation scenarios, balancing optimistic, pessimistic, and realistic outcomes to calculate the potential worth of a company.

The approach captures the varying possible futures of a high-growth company by analyzing scenarios that help investors understand the risks and rewards associated with their investments. Unlike traditional valuation methods that may rely solely on discounted cash flows or market comparables, the First Chicago Method acknowledges that early-stage companies often do not have stable or predictable cash flows. It mitigates this by considering different exit strategies and holding periods, viewing the investment through multiple lenses that align with an investor’s perspective and strategies for varying company stages.

Key Takeaways

  • The First Chicago Method integrates both multiples-based and cash flow valuation approaches.
  • It is particularly useful for valuing companies with dynamic and uncertain growth prospects.
  • This method facilitates investor decision-making by incorporating different valuation scenarios.

Overview of the First Chicago Method

The First Chicago Method is an influential valuation framework within the field of business evaluation. This methodology is particularly prominent among venture capital and private equity investors who are trying to ascertain the value of companies, especially those in the growth phase.

Key Characteristics:

  • Combination Approach: It merges elements of both quantitative and qualitative analysis by incorporating scenarios that reflect different possible future states of the company.
  • Scenario Analysis: Typically, three potential scenarios are considered: a pessimistic case (worst-case), a base case (most likely), and an optimistic case (best-case).

Valuation Process:

  1. Develop Scenarios: Analysts craft detailed projections for each of the three scenarios.
  2. Assign Probabilities: Each scenario is given a probability weight based on its likelihood.
  3. Calculate Values: Future cash flows within each scenario are determined and then discounted to present value.
  4. Aggregate Results: A probability-weighted valuation is calculated by summing the present values of all scenarios.

This method stands out because it recognizes the inherent uncertainty in predicting a company’s future performance, particularly for startups and high-growth firms. By accounting for various outcomes, the First Chicago Method offers a robust and flexible valuation that reflects the risky nature of venture capital investments. It skillfully balances the detailed quantitative aspects of cash flow analysis with the qualitative judgments about the company's future prospects.

Valuation Fundamentals

The First Chicago Method is a sophisticated technique combining the Discounted Cash Flow (DCF) and multiples-based valuation models, specifically tailored for growth companies and employed by professional VCs and private equity investors. It hinges on assessing potential outcomes, incorporating probability weights, and accounting for various risk factors in a meticulous valuation process.

Understanding Discounted Cash Flow

The Discounted Cash Flow (DCF) method is central to the First Chicago Method, predicated on the principle that a company's value is the sum of its future cash flows, adjusted to their present value. This adjustment uses a discount rate, which often incorporates the weighted average cost of capital (WACC) or the cost of equity derived from the Capital Asset Pricing Model (CAPM).

Exploring Multiples-Based Valuation

In juxtaposition to DCF, multiples-based valuation relies on comparing a company to its peers using multiples like EBIT or revenue. This approach, also known as comparable company analysis (comps), evaluates based on market-oriented metrics and is integral in triangulating a venture's value.

Venture Capital and Investment Principles

Professional VCs and private equity investors employ valuation models that suit the high-risk, high-reward nature of their investments. They seek a required return that compensates for the risk undertaken, which is particularly high in growth companies with less predictable cash flows.

Probability Applications in Valuation

The First Chicago Method uses a probability-weighted valuation considering various scenarios—optimistic, realistic, and pessimistic—alongside their likelihood. Assigning a probability weight to each scenario ensures a more nuanced valuation, factoring in the unpredictable nature of start-ups and growth firms.

Terminal Value Concept

Terminal value reflects the company's value at the end of the explicit forecast period. It is pivotal for long-term analysis, accounting for the bulk of value in a DCF, signifying the expected cash flows beyond the projected period until the exit-horizon.

Risk Assessment and Discount Factors

Risk factors influence the discount rate, which adjusts future revenues and earnings to their present value. A higher risk premium implies a higher rate, lowering the valuation. This accounts for inherent uncertainties in the business, market, and macroeconomic environment.

Income-Based Business Value Assessment

This technique evaluates firms based on income, typically emphasizing earnings as a reliable measure of performance. It facilitates a grounded perspective, particularly when comparing firms within the same industry.

Weighted Sum Valuation

Combining DCF and multiples approaches, the First Chicago Method represents a weighted sum where the final valuation mirrors a balanced blend of probability scenarios, their associated values, and economic realities.

Role of Historical Financial Analysis

Historical financial results provide a foundation for valuation, offering insights through trend analysis. Serving as a factual basis, historical data helps establish the credibility of financial forecasts and augments the evaluation of a company's prospective worth.

Market Trends and KPIs Interpretation

Understanding the impact of fundamental market trends and interpreting key performance indicators (KPIs) aid in fine-tuning valuation models. It allows for the synthesis of industry dynamics with a company's operational metrics, aligning the valuation with market realities.

Financial Forecasts and Projections

Forecasts play a critical role in the First Chicago Method. They translate assumptions about revenue growth, market penetration, and cost management into quantifiable cash flows. Precise financial forecasts are instrumental for a credible and defendable valuation.

Case Scenarios in First Chicago Method

The First Chicago Method applies a distinctive approach to valuation by assessing three specific potential outcomes for a company's financial future: base, best, and worst-case scenarios. Each scenario is crafted with the understanding of inherent uncertainties, especially for early-stage companies, and incorporates a probability-weighted mechanism to project possible financial paths.

Base Case Analysis

In the Base Case Analysis, one considers the most probable outcome for the company's operations under normal circumstances. The scenario is constructed with the assumption of the company continuing on its current trajectory without significant changes or interruptions. Financial projections under the base case are centered on the company's current revenues and growth rates, factoring in the industry's average performance. This scenario often implies that the company will neither exceed nor fall short of the market expectations significantly.

Upside and Best-Case Scenario

The Upside and Best-Case Scenario, also referred to as the best-case, represents the most favorable outcome for the company. It outlines a future where the company might outperform expectations due to successful strategy-shifts, market reception, or other factors contributing to higher than anticipated revenues. The upside case assigns a lower probability given the inherent optimism involved, acknowledging that while such outcomes are possible, they are not as likely as the base case.

Downside and Worst-Case Scenario

Conversely, the Downside and Worst-Case Scenario envisages a situation where the company could underperform and potentially face total loss or a drastic need for strategy changes. This scenario considers challenging market conditions, unsuccessful product launches, or any hurdles the company may face that could impede its ability to generate expected revenues. The worst-case scenario is vital for understanding the potential risks and preparing for adverse outcomes, yet it typically carries the lowest probability of the three scenarios.

Investment Strategies for Different Company Stages

Investment strategies vary significantly across different stages of a company's life cycle, with each stage presenting distinct challenges and opportunities for investors. Understanding the nuances of each can guide investment decisions and the adoption of suitable methodologies for valuation.

Evaluating Early-Stage Companies

When assessing early-stage companies, investors seek to understand the potential return on investment given the higher risks involved. Startup valuation often relies on qualitative metrics due to the lack of historical financial data. At this juncture, the First Chicago Method can be pivotal in projecting future cash flows across various scenarios—each reflecting different probabilities of success:

  • Worst-Case Scenario: considers the risk of failure and its impact on investment return.
  • Base-Case Scenario: presupposes a standard projection grounded in current assumptions and market conditions.
  • Best-Case Scenario: captures the prospects of exceptional performance and associated returns.

Assessing Growth Companies

In the case of growth companies, the evaluation emphasizes both quantitative and qualitative factors. Investors analyze past performance and compare it to future potential, focusing on the exit-horizon—the point at which they can expect a return.

  • The anticipated annual cash flows are typically more reliable for growth companies and are discounted to their present value to account for risk and return expectations.
  • Indicators such as market share expansion, revenue growth rates, and scaling capabilities are pivotal for informed valuation and strategic investment decisions.

Divestment Strategies

Divestment, the process of selling an investment, is critical as it represents the actualization of the investment's return. Divestment strategies must consider the optimal exit-horizon to maximize returns. A strategic approach includes:

  • Monitoring market conditions to align the timing of the sale with favorable conditions.
  • Evaluating the company's stage of growth to ensure it is positioned to attract potential buyers or to go public effectively.

In each of these subsections, return, exit-horizon, early-stage companies, startup valuation, growth companies, and divestment are inseparably linked to the overall strategy investors employ. They determine not just the valuation method but also the timing and approach to investments and eventual exits from them.

Special Considerations

In the intricacies of the First Chicago Method, investors and analysts should weigh context-specific factors that can significantly influence the valuation outcome. These special considerations are critical for nuanced and robust analysis.

Private Equity Secondary Market

In the private equity secondary market, firms like Madison Dearborn Partners and GTCR utilize the First Chicago Method as a nuanced approach to address the liquidity challenges and unique valuation circumstances of these assets. Investors often adjust their calculations for the anticipated time to liquidity, a key metric for secondary market transactions.

Assessing Intangible Assets

When considering intangible assets, the First Chicago Method's scenario-based approach allows for a more structured valuation against fundamental market trends. ValuAdder and similar data providers can aid in quantifying these assets by supplying industry-specific information that assists in the intricate process of assessing intangible asset value.

Market Orientation and Strategy Shifts

Understanding a company's market orientation and potential strategy shifts allows analysts to better forecast future financial performance scenarios. This is particularly crucial within the First Chicago Method framework, as the value of a company might significantly change with the execution of a new strategy or realignment with market demands.

Short-Term Vs. Long-Term Analysis

In the discussion of short-term analysis versus long-term analysis, the First Chicago Method affords the flexibility of considering both. Firms are provided with a framework to account for short-term volatilities against the backdrop of long-term strategic plans, offering a comprehensive view that reflects both immediate returns and enduring value.

Exit Strategies and Holding Period

In evaluating private equity investments, the First Chicago Method takes into account various exit strategies that investors may choose to employ. These strategies are pivotal for realizing the potential gains from an investment. The exit-horizon, which is the projected time frame for exiting an investment, is closely linked with the holding period—the length of time an investment is held before divestment.

Holding Period Considerations:

  • Short-term holding (<5 years): Often involves aggressive growth strategies with a focus on swift value creation and exit.
  • Medium to long-term holding (5-10 years): Allows for the implementation of transformative changes within the company to incrementally add value.

Typical Exit Strategies:

  1. Initial Public Offering (IPO): Offering company shares on a public exchange.
  2. Mergers & Acquisitions (M&A): Selling the company to a strategic buyer.
  3. Secondary Sale: Transferring ownership to other private equity firms.
  4. Management Buyout (MBO): Enabling company's management to acquire a portion or all of the business.

Investors consider the exit-horizon and holding period to estimate the potential exit multiple, which is critical in the First Chicago valuation model. These time-focused elements help in creating tailored strategies, whether it's quick strategic improvements for short-term exits or substantial operational changes for longer-term exits.

It should be noted that the selected exit strategy may affect the ultimate valuation of the investment, as each approach comes with its own risk profile and potential for value maximization. Hence, investors need to forecast multiple scenarios regarding exit-horizon and associated cash flows to accurately apply the First Chicago Method.

Advanced Valuation Models

In the realm of valuation, the precision of advanced models is paramount. They utilize a sophisticated blend of quantifiable tools and leverage extensive industry data to deliver probability-weighted valuation outcomes, often employing the weighted sum of different scenarios.

Quantitative Tools and Models

The First Chicago Method stands out among advanced valuation models for its robust approach to uncertainty in early-stage company valuations. This method incorporates a weighted sum of probable outcomes to account for various possible future performances of a company. It typically considers three scenarios:

  • Base case: The expected scenario, considering current trends and moderate assumptions.
  • Best case: An optimistic scenario that factors in potential positive market shifts and strategic successes.
  • Worst case: A conservative scenario which accounts for challenges and market downturns.

Each scenario is assigned a probability and a corresponding cash flow projection. The model then computes a probability-weighted valuation by multiplying each scenario's value by its probability and summing the results.

Leveraging Data from Industry Providers

Advanced valuation models, like the First Chicago Method, benefit significantly from the high-quality data supplied by industry providers. These providers offer vital statistics on market trends, comparative company metrics, and industry benchmarks. Here's how they enhance the valuation process:

  • Relevant data ingestion: Data providers funnel in critical information that shapes the assumptions and inputs of each hypothetical scenario.
  • Probability adjustments: Analysts can adjust the probability weightings within the model based on real-time industry data, leading to more accurate valuations.

For instance, a company can be valued by comparing its metrics to similar companies within its industry, as reported by data providers. This comparison informs the multiples used in the quantitative models, refining the accuracy of the forecasted cash flows and resultant enterprise valuation.

Investor Perspective

In analyzing the First Chicago Method, investors, particularly those in venture capital and private equity, scrutinize varied scenarios to gauge both potential returns and inherent risks. This method serves as a cornerstone tool for shaping investment decisions.

Venture Capitalist Viewpoint

Venture capitalists, or professional VCs, often use the First Chicago Method due to its adaptability to high-growth potential startups. This methodology allows them to blend traditional valuation techniques with scenario analyses, accommodating the volatility and uncertainties typical of early-stage ventures. By evaluating optimistic, realistic, and pessimistic outcomes, VCs can estimate a more encompassing picture of potential investment returns.

Private Equity Insights

Private equity investors leverage the First Chicago Method for its capacity to factor in the unique growth trajectories and risk profiles typical of their investments. These investors concentrate on the method’s ability to measure the impact of strategic business decisions and market conditions on a company’s value. This approach aligns closely with the hands-on investment style and long-term growth focus inherent in private equity.

Evaluating the Return on Investment

For both venture capital and private equity investors, the First Chicago Method is crucial in calculating the expected return. By assigning probabilities to different valuation outcomes, they derive a probability-weighted value, which helps determine if the potential return aligns with the investor's required return. This calculation gives investors a quantitative foundation to compare the attractiveness of various investment opportunities.

Understanding the Risk Premium

Assessing the risk premium is integral to the First Chicago Method. It acknowledges that investments in startups and high-growth firms carry significant risk, reflected in the required return. Investors scrutinize cash flow scenarios to ascertain the risk premium, the additional return over the risk-free rate, demanded to compensate for uncertainties. By doing so, they integrate both qualitative and quantitative assessments to derive a valuation that embodies the unique risk-reward profile of each investment.

Calculating Cost of Capital

In valuing companies, particularly when applying the First Chicago Method, accurately calculating the cost of capital is fundamental. It influences the discount rate and, by extension, the present value of future cash flows.

Applying WACC and CAPM Models

Weighted Average Cost of Capital (WACC) is the average rate of return a company is expected to pay its security holders to finance its assets. When applying the WACC, analysts consider both the cost of equity and the cost of debt, proportionally weighted. The basic formula for WACC is:

[ WACC = \left(\frac{E}{V} \times Re\right) + \left(\frac{D}{V} \times Rd \times (1 - Tc)\right) ]


  • (E) = Market value of the equity
  • (D) = Market value of the debt
  • (V) = (E + D) (Total firm value)
  • (Re) = Cost of equity
  • (Rd) = Cost of debt
  • (Tc) = Corporate tax rate

Determining the Cost of Equity

The Capital Asset Pricing Model (CAPM) is utilized to establish the cost of equity. CAPM reflects the idea that investors need to be compensated in two ways: time value of money and risk. The formula is:

[ CostofEquity (Re) = RiskFreeRate + Beta \times (MarketReturn - RiskFree~Rate) ]

  • Risk-Free Rate represents the return on an investment with no risk of financial loss.
  • Beta measures the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
  • Market Return signifies the expected return of the market over the risk-free rate.

The CAPM offers a model that acknowledges one's investment's risk and provides a way to calculate the expected return, which is integral in deriving the cost of equity when calculating the firm's WACC.

Analyzing Market Data and Comps

When applying the First Chicago Method of valuation, it’s essential to understand how market data and comps influence value. This requires a detailed analysis of comparable companies, identification of pertinent market trends, and recognition of key performance indicators (KPIs).

Comparable Company Analysis Review

Comparable company analysis (CCA) is a process in which one assesses the value of a company relative to similar entities in the market. Analysts select a peer group of companies with similar characteristics and compare various financial metrics. The most common metrics used include:

  • Price-to-earnings (P/E) ratio
  • Enterprise value-to-EBITDA (EV/EBITDA)
  • Price-to-sales (P/S) ratio

These comparisons provide foundational data points for determining market valuations, aiding in creating grounded financial forecasts for the First Chicago Method.

Understanding Market Trends

Market trends substantially affect valuations as they dictate the environment in which companies operate. Analysts look for patterns and tendencies in the following areas:

  • Industry growth rates
  • Regulatory changes
  • Technological advancements
  • Consumer behavior shifts

By understanding market trends, one can better forecast future cash flows and growth prospects, which are crucial to the First Chicago Method's scenario analysis.

KPIs and Their Impact on Valuation

Key performance indicators (KPIs) serve as quantifiable measures of a company's success and are integral to its valuation. Relevant KPIs vary by industry but may include:

  • Revenue growth rate: a fundamental indicator of company's scale expansion.
  • Gross margin: reflecting the cost efficiency and pricing strategy.
  • Customer acquisition cost (CAC): a measure of the investment required to attract new customers.

Incorporating KPIs into valuation analysis ensures that the financial scenarios in the First Chicago Method are supported by actual company performance data.

Ethics and Professional Consideration

In the context of the First Chicago Method, professionals are tasked with integrating ethical considerations and industry best practices throughout the valuation process.

Maintaining Objectivity

Analysts must exercise impartiality in the assessment of data to safeguard the integrity of the valuation. Objectivity necessitates meticulous handling of data from data providers, ensuring that such data undergoes rigorous verification. Key practices include:

  • Scrutinizing the reliability and relevance of the financial forecasts.
  • Mitigating personal biases that may influence valuation outcomes.

Adhering to Industry Standards

Compliance with established industry standards is critical for credibility in valuation exercises. Professional ethic dictates that one should:

  • Follow transparent methodologies aligning with the First Chicago Method's principles.
  • Ensure calculations are reproducible and align with investor expectations and regulatory frameworks.

Analysts should regularly update their knowledge to stay in line with the evolving standards of the financial industry and data analysis methods.


The First Chicago Method offers a nuanced approach to company valuation, factoring in multiple potential outcomes. It integrates the use of probability-weighted scenarios, which allows for a more dynamic assessment tailored to companies with uncertain futures, such as startups and early-stage ventures.

Valuers appreciate the method for its accommodation of variability, acknowledging that it operates on a spectrum of potential results rather than a single-point estimate. This recognizes the inherent risk and unpredictability associated with high-growth and early-stage companies. The primary components of the First Chicago Method involve:

  • Best-case scenario: An optimistic outlook on future performance and cash flows.
  • Base-case scenario: A realistic, most-likely outcome of business operations.
  • Worst-case scenario: A conservative approach considering possible challenges and setbacks.

Each scenario is assigned a probability that reflects its likelihood of occurrence. The summation of these probability-weighted values leads to a consolidated valuation.

The method combines both elements of multiples-based valuation and discounted cash flow (DCF) analysis, offering a comprehensive view that captures both market-relative and intrinsic value.

It's important to account for the First Chicago Method's limitation in not considering intangible assets. Nonetheless, this approach is particularly effective for companies with limited historical data, where traditional valuation models may fall short.

In practice, the First Chicago Method is a strategic tool that equips investors and financial analysts with a structured yet adaptable framework for valuing high-risk investments.

Frequently Asked Questions

In this section, investors and analysts will find a concise exploration of the First Chicago Method as it applies to startup valuation, highlighting specific processes and comparisons.

How is terminal value determined in the First Chicago Method?

In the First Chicago Method, the terminal value is typically calculated by estimating the startup's cash flows at the end of the projection period and then applying a terminal growth rate or exit multiple to determine its end value within the respective scenario.

Can you describe the step-up calculation in startup valuation using the First Chicago Method?

A step-up calculation in the First Chicago Method involves adjusting the valuation of a startup based on achieved milestones or growth stages, which are likely to increase the company's value at subsequent funding rounds or exit.

What is the typical framework for evaluating a startup's potential investment value via the First Chicago Method?

The typical framework involves creating a base case, an optimistic case, and a pessimistic case for the startup's future financial performance. These scenarios are then weighted based on their probability and aggregated to estimate the startup's value.

How does the First Chicago Method compare to conventional valuation methods for startups?

The First Chicago Method incorporates scenario analysis and probability weighting more explicitly than many conventional valuation methods, offering a tailored approach to startups where cash flows are unpredictable and traditional metrics may not apply.

What financial analysis considerations are unique to the Venture Capital model, particularly with the First Chicago Method?

Unique considerations include evaluating the startup's growth potential, market size, and technology risks with a focus on scenarios that reflect varying degrees of success, which aligns with the high-risk, high-return nature of venture capital investments.

Does the First Chicago Method provide a template for assessing the exit valuation of a startup?

Yes, the First Chicago Method considers potential exit scenarios, including acquisitions and IPOs, to provide a range of expected exit valuations, taking into account different market conditions and company performance trajectories.