Investment banking is a specialized division of banking that helps corporations, governments, and individuals in raising capital and provides consultancy services on mergers and acquisitions (M&A). Investment banks act as intermediaries between investors and organizations that need money. The banks underwrite debt and equity securities, offer guidance to issuers on stock placement, and counsel corporates in restructuring to enhance value. Investment Banks act as brokers, selling shares for a commission by buying and reselling shares to the public. For example, if the government needs funds for constructing railways, it might turn to investment banks to issue bonds for raising finance.
What is the process of investment banking?
Investment banks connect issuers of securities with buyers. Their functions include:
– Raising funds by issuing stocks or helping new companies to go public through an initial public offering (IPO)
– Finding corporate investors for bonds to help companies expand through debt capital
– Assisting in mergers and acquisitions by counseling on structuring deals
– Guiding on corporate restructuring to increase the efficiency of operations for maximizing profit
For example, say a corporate client XYZ wants to buy another business called ABC. An investment bank will find out for XYZ the worth of company ABC, project long-term profits, prepare essential documents for striking the deal and also advise on the suitable time for offering the deal. Here, the investment bank is working on the “buy” side.
The role of investment banks on the “buy” side involves handling the purchase of investment instruments like:
– Pension funds
– Mutual funds
– Private equity funds
– Hedge funds
– Life insurance
Another investment bank might be working on the “sell” side where it handles the trading. Here, a company that is planning to issue new stock through an IPO may approach an investment bank. In a financial transaction, the investment bank’s function starts with pre-underwriting, where it assesses risks. Then the bank inspects the client company’s financial papers for accuracy and creates a prospectus to explain potential investors about the client’s offerings before shares are brought to the market. Thus the investment bank facilitates security transactions by marketing and selling IPOs to the public. The bank is thus helping its client to raise capital.
Why is investment banking important?
Investment banking plays a significant role in the economic growth of a country. For boosting the economy, businesses must get access to capital for expansion, innovation, and more. It is the function of the investment bank to arrange for funds through issuing securities and selling debentures. The bank might even do a “bought deal” by committing to purchase the entire security offerings of its client company. Subsequently, the bank sells the shares on the market. This way, the bank ensures that the company raises the required capital amount, mitigating financial risks for the client. The banks profit by marking the price of the shares up from the amount it paid while purchasing, but it faces the risk of losing its outlay if it overvalued the shares. If the bank fails to estimate the price of the stock accurately, it can end up having to sell the stocks for a price lower than what it paid initially. Thus, the client is safeguarded, and the bank assumes the risks.
What is the job of investment bankers?
“Successful investing is anticipating the anticipation of others. ” – John Maynard Keynes, British economist.
Investment bankers need to stay informed about the prevailing investment climate and allocate costs to financial instruments and security offerings. Their job is to maximize revenues while maintaining regulatory requirements. Moreover, they need to have the ability to understand latent risks and forecast potential gains before the client moves ahead with a financial deal. Thus clients like corporations, governments, and others seek the advice of investment bankers for charting their business growth as per current economic conditions.
Investment banks offer the following services:
When a company seeks equity funding, investment banks provide underwriting services that involve raising capital for a corporate by selling stocks or bonds. The bank evaluates the client company and decides on the best price for the stocks. It also markets the shares to potential investors.
The steps to pricing, marketing, and completing a deal:
Offering financial advice
Apart from raising capital through IPOs, investment banks also guide client companies on building funds through alternative methods. The banks counsel the clients on every aspect of financing and asset management.
Guiding mergers and acquisitions
When a client wishes to acquire another business organization, investment banks evaluate the worth of the acquisition. The banks estimate a fair price, help in negotiating the deal, and structure the transaction for a smooth implementation of the purchase.
Who are the clients of investment banks?
A wide variety of clients seeks the help of investment bankers in raising capital and meeting M&A requirements.
Governments: Investment banks help governments to raise money for administrative and infrastructural projects by trading securities.
Corporates: Both public and private companies approach investment banks when they want to go public through IPOs for expanding their businesses. They also seek the counsel of the banks while making acquisitions or for selling business units. The banks also conduct market research for the corporations and offer overall financial guidance.
Institutions: Institutional investors who provide analysis to help people trade securities take the help of investment bankers. Private equity firms looking to obtain and sell portfolio companies also take the help of investment banks.
What are the skills required in investment banking?
1. Financial modeling: For underwriting and M&A activities, investment bankers need to perform different types of financial modeling like developing discounted cash flow models, 3-statement models, LBO models, and so on.
2. Evaluating businesses: Investment bankers need to be proficient in valuation methods such as DCF analysis, comparable company analysis, precedent transactions, and others.
3. Building pitch books: Investment banking requires the preparation of pitch books and attractive presentations to pitch ideas and win new clients.
4. Preparing financial documents: The banks are involved in creating transaction documents like term sheets, investment portfolios, confidential information memorandum (CIM), confidentiality agreements, and more.
5. Business development: Investment bankers must be skilled in sales and marketing techniques for converting prospects into clients for business development.
6. Managing relationships: The existing clients must be kept satisfied through value-added services.
7. Negotiation skills: Negotiation between buyers and sellers is the primary function of investment bankers. Thus they need to have a sound grasp over negotiation tactics to maximize the profits of the clients.
What are some of the notable investment banks?
Some of the most significant investments include Barclays Capital, JP Morgan, Bank of America, Goldman Sachs, Citigroup Investment Banking, Deutsche Bank, and Merrill Lynch.