First Chicago Method

First Chicago Method

Procedures to Perform the First Chicago Method

The First Chicago Method is a valuation approach primarily used for startups, early-stage ventures, and private companies with uncertain cash flows. It combines elements of the Discounted Cash Flow (DCF) method and scenario-based valuation to provide a probability-weighted value.

Step 1: Understand the Business and Context

  • Assess the business model, market position, and growth potential.
  • Identify key value drivers, such as revenue streams, customer acquisition, and competitive advantages.
  • Evaluate the funding stage and risk profile (e.g., early-stage startup, growth-phase company).

Step 2: Define Key Valuation Scenarios

Since startups and high-risk businesses face multiple potential outcomes, the First Chicago Method uses three core scenarios:

  1. Best Case (Success Scenario)

    • The company scales successfully, achieving high market penetration.
    • Strong revenue growth, profitability, and potential IPO or acquisition.

  2. Base Case (Moderate Scenario)

    • The company grows steadily but faces competition and operational challenges.
    • Achieves profitability but at a lower level than the best-case scenario.

  3. Worst Case (Failure Scenario)

    • The company struggles with execution, competition, or market adoption.
    • Leads to minimal value, a distressed sale, or bankruptcy.

Each scenario should be financially modeled with projected revenue, expenses, and cash flows.

Step 3: Develop Financial Projections for Each Scenario

For each scenario, estimate:

  • Revenue Growth (based on market size, adoption rate, and pricing).
  • Operating Expenses (R&D, sales, marketing, and admin costs).
  • EBITDA / Free Cash Flow (FCF) (profitability expectations).
  • Exit Strategy (IPO, acquisition, or liquidation).

Use comparable industry benchmarks and historical performance (if available) to build reasonable assumptions.

Step 4: Apply Discounted Cash Flow (DCF) Analysis

For each scenario:

  1. Project Free Cash Flows (FCFs) for 5–10 years.

  2. Determine an appropriate Discount Rate (typically, the startup’s required rate of return, often 20–40%).

  3. Estimate Terminal Value (using a multiple of EBITDA or a perpetuity growth model).

  4. Calculate Present Value of Cash Flows using:

    PV=∑FCF_t(1+r)^t+TV(1+r)^n

    Where:

    • FCF = free cash flow
    • t = year
    • r = discount rate
    • TV = terminal value

Step 5: Assign Probability Weights to Each Scenario

Estimate the likelihood of each scenario based on industry analysis, company-specific risks, and investor judgment.

For example:

  • Best Case: 30% probability
  • Base Case: 50% probability
  • Worst Case: 20% probability

The total probability must sum to 100%.

Step 6: Compute the Probability-Weighted Valuation

First Chicago Valuation=(Best Case Value×P1)+(Base Case Value×P2)+(Worst Case Value×P3)

Where P1,P2,P3 are the assigned probabilities.

Step 7: Conduct Sensitivity Analysis

  • Test how changes in revenue growth, margins, or discount rates impact valuation.
  • Consider macroeconomic conditions and industry trends.

Step 8: Finalize and Present the Valuation

  • Clearly document the assumptions, scenarios, and probability assignments.
  • Provide valuation in a range (e.g., $50M – $100M, based on scenario outcomes).
  • Compare with alternative methods like comparable company multiples or precedent transactions for cross-validation.

Key Advantages of the First Chicago Method

✔ Accounts for multiple future outcomes.
✔ Useful for startups and high-growth businesses.
✔ Provides a probability-weighted valuation rather than a single estimate.