Valuing a business for outside investment: the First Chicago Method
One of the most challenging tasks you are likely to face when considering an outside investment is how to determine the value of your company.
Referred to by venture capitalists as the post-money valuation, this key step gives you a number of strategic decision data points:
- What the entire company is worth, known as the enterprise value.
- How the business ownership interests are split between the founding team and external investors.
- Whether the founders retain the controlling ownership of the company after the investment has been made.
- Is the investment worth taking given its effect on business value?
Business valuation of a high growth firm – First Chicago Method
Since the infusion of outside capital is likely to change the business earnings prospects going forward, the Discounted Cash Flow method is the standard choice for investment-driven business valuation.
This income-based valuation method lets you focus on the company’s earnings prospects and risk directly. The result is the “present value” of the firm – what it is worth today.
The additional capital can make a major difference to the business’s earnings prospects. Since the future is uncertain, it is best to create a number of forecasts and run your Discounted Cash Flow valuation for each:
- Best case – under the most favorable assumptions of business performance.
- Base or most likely case.
- Worst case – if the business encounters unexpected “head winds” in the near term.
You can view the results as a range of possible business values or average them to come up with a single valuation number.
Note that this valuation analysis is inherently forward looking and involves a number of subjective assumptions on your part. It is a very good idea to check the market in order to confirm your valuation results. Recent sales of comparable businesses give you an objective evidence of selling prices.
If you relate the business selling prices to the the firms’ financial performance, you can see how the market values these companies. More importantly, using the valuation multiples derived from the market comps you can estimate the market value of your own business.
This combination of the comparative market value analysis and Discounted Cash Flow valuation is known as the First Chicago Method.
The method’s power is in combining the theoretically precise yet subjective business valuation based on its income prospects with a highly objective “reality check” of business market value based on the actual business sales.
You can easily implement the First Chicago method using the ValuAdder business valuation software:
- Select the Market Comps tool for your market-based valuation.
- Create a number of Discounted Cash Flow valuation tools, one for each valuation scenario.
- Calculate your business valuation results.