According to most people, investment banking is all about sitting in skyscrapers making billion-dollar deals. But the real story is far less flamboyant, yet arguably even more interesting.
In simple terms, investment banking is a method of controlling the flow of money. The goal of investment banking is channeling cash from investors looking for returns into the hands of entrepreneurs and business builders who although have the ideas but are short on money.
5 most common roles of major investment banking firms
Mergers and Acquisitions
Both terms refer to a situation when two firms combine together to form a single company. This process creates a synergy, when two firms combined are worth more than either firm is worth alone (1+1 = 3). However, there is a small difference between the two. In a merger, it’s a combination of equals, i.e., both firms are approximately the same size and both agree on the combination. Whereas, in an acquisition, a larger entity buys a much smaller entity or when the decision to combine is not mutual (takeover).
But why doing that??
Business expansion and introducing a new product line: When a large company feels they need to enter into a new industry where they were not present already or want to fill in the gaps in their product line, they acquire a smaller firm that already operates in that business and has its roots set up.
Getting big and beating the rivals: Building a business from scratch includes hiring people, designing the product, financing, marketing and finally getting it to the market. This takes time. Combining with an already established company allows to directly enter the market and competing sooner than later.
Geographic expansion: M&A deals are a quick way to spread into other regions/countries, hence making a worldwide presence.
Leveraged buyouts
Typically, in an LBO, the acquiring company buys another company with a large amount of debt, and then pays off the debt over time using the cash flow generated by the business. The debt is usually taken using the acquired company as leverage.
LBOs are typically done by specialized firms, called financial sponsors (eg. private-equity firms). These investment firms typically have a host of limited partners, or investors, who provide money to the private-equity firm. The private equity firm uses the cash from the limited partners, plus a heap of debt, to buy companies, fix them up, and then sell them for a tidy profit.
How would they sell the company afterward??
IPOs – One way to get out of the buyout is by selling the company to the public. This is done by modeling the company up into shares that are sold to public investors.
Selling to the interested buyers: If selling to the public doesn’t work, the private-equity firms might tap into some private firms who might be interested in buying the company.
Recapitalization: If they can’t find a buyer or if the timing isn’t right, they might go for restructuring the finances of the company. For example - The company may take on an additional investor as a way to reduce the amount of debt.
Initial public offerings
IPOs are the stocks that the company sells to the general public for the first time. Companies go for the IPOs to raise funds when other options (e.g. Venture capitalists, bank loans, and crowdfunding) to raise money don’t feel right or work out properly.
Investment bankers are involved in the very onset of a company going public, and they’re the keys to making the deal happen. When investment bankers find themselves in the role of selling securities, especially in an IPO, they’re often called the underwriters.
Note: Investment bankers also assist in taking the company back to being private. When a company is suffering, and needs to make major changes in a painful restructuring, going private is a great option.
Research for potential buyers and sellers
For the sellers, investment bankers not only help in preparing the securities to be sold but also help in finding a potential buyer. For buyers, they assist in finding profitable investing opportunities.
Two types of analysts that play a major role in this process are –
Sell-side - analysts that research on various companies and tell investors whether to buy the stock. These analysts are called sell-side analysts because it’s their job to highlight stocks they say are worthy of investment, but they don’t actually invest in the stocks themselves.
Buy-side - analysts who are actually involved in investing the cash if they decide to purchase a security. These analysts consider the demands of the investors who have given them money to invest, be it mutual fund investors or pensioners with money in the pension plan. They might do their own research or sometimes rely on the sell-side research reports.
Trading
Trading desks present in the majority of the investment banks are responsible for buying and selling securities. They typically buy and sell everything from stock to bonds, futures contracts, commodities, and foreign exchange contracts.
The trading operations are made to handle the demands of customers of the firm who need to purchase or unload large amounts of stock or other investments. Investment banking firms also invest their own money to make quick bucks out of the idle cash present with them.
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