First Chicago Method

         Developed at First Chicago Corporation's venture capital group,employs a lower discount rate, but applies it to an expected cash flow.That expected cash flow is the average of the three possible scenarios, with each scenario weighted according to its perceived probability.The equation to determine the investor's required final ownership is :




                           Future value of investment - 
                        Future value of non-IPO cash flow
Required final = -----------------------------------------
   ownership              Probability (Success)

                            (Forecast terminal Value)


       This formula differs from the original basic venture capital formula in two ways: (1) the basic formula assumes there are no cash flows between the investment and the harvest in Year 5; the future value of the immediate cash flows is subtracted from the future value of the investment because the difference between them is what must be made up for out of the terminal value; and (2) the basic formula does not distinguish between the forecast terminal value and the expected terminal value. the traditional method uses of a high discount rate. The formula employs the expected value of the terminal value.

Is also use in the valuation of growth companies which often do not have historical financial results that can be use for meaningful comparable company analysis. It is used by venture capital and private equity investments that combines elements of both multiples-based valuation and discounted cash flow.

• ·         Multiple-based valuation – method of estimating the value of asset by the value assessed by the market for similar or comparable assets.
• ·         Discounted cash flow -  valuing a project, company or asset using the concepts of the time value of money.

Time value of money – value of money figuring in a given amount of interest earned over a given amount of time.`

Fundamental Method

Fundamental Method

               

     This method is simply the present value of the future earnings stream. This can be problematic for you because earnings, in a growth company are pushed into the future. Once a company decides on a high-potential growth strategy, there are no calculated earnings because all cash is applied to increase the growth rate. The purpose of this, is to reap a huge increase in earnings in future years.

The Venture Capital Method

This method is appropriate for investments in a accompany with negative cash flows at the time of the investment, but which in a number of years is projected to generate significant earnings. 


Venture capitalists are the most likely professional investors to partake in this type of investment, thus the reference to the venture capital method.

STEPS INVOLVED IN THIS METHOD:

1.       Estimate the company’s net income in a number of years, at which time the investor plans on harvesting. This estimate will be based on sales and margin projections presented by the entrepreneur in his or her business plan.

2.       Determine the appropriate price-to-earnings ratio, or P/E ratio. The appropriate ratio can be determined by studying current multiples for companies with similar economic characteristics.

3.       Calculate the projected terminal value by multiplying the net income and the P/E ratio.

4.       The terminal value can then be discounted to find present value of the investment. Venture capitalists used discount rates ranging from 35 percent to 80 percent, because of the risk involved in these type of investments.

5.       To determine the investor’s required percentage of ownership, based on their initial investment, the initial investment is divided by the estimated present value.

SUMMARY OF THE STEPS:

Final ownership  = Required future value (investment)

     Required        _____________________________

                                     Total terminal value

                                        

            (1 + IRR)years (investment)

                               

                  =    ---------------------------------------------

                            P/E ratio (terminal net income)

6.       Finally, the number of shares and the share price must be calculated by using the following formula:

   Percentage of ownership

    Required by the investor

New shares = -----------------------------------------------

                            1 – Percentage ownership required

by the investor  x old shares

This method commonly used by venture capitalists because the make equity investments in industries often requiring a large initial investment with significant projected revenues; in addition, the percentage of ownership is a key issue in the negotiations.