Investment banking is an undeniably attractive industry. Million-dollar bonuses, lavish lifestyles, and highly secretive organisations are all brought to mind when one thinks of investment banking. Recently, in such films as The Big Short and Margin Call, investment banks have been depicted as cut-throat, merciless organisations – firms driven to generate profit without regard for consequence. Although many members of the financial world have debated the accuracy of such films, investment banking undoubtedly pervades every aspect of modern life, from telecommunications to home mortgages. But what is an investment bank? How do they work?
What is investment banking?
Fundamentally, an investment bank is a company or corporate division devoted to generating capital for other entities (e.g. companies and governments). Investment banks may also provide advisory services for such entities. Generally speaking, investment banks assist clientele in undertaking complex, often large financial transactions. Unlike private equity corporations, investment banks rarely invest in client’s corporations themselves, instead financially supporting client’s pursuance of such aforementioned financial transactions. In modern times, full-service investment banks raise capital in numerous different ways, although all aim to support a client’s desired financial transaction or deal. For example, an investment bank may raise capital for a company by providing the financial means for the company to sell shares (and, by extension, raise capital). From an advisory perspective, investment banking firms may also provide consulting services for the reorganisation of a company after acquisition. Both services intend to solve business issues for the client company, enhancing their capacity for financial success and long- term performance. At its most basic level, investment banks assist other corporations, governments, and businesses with financial and organisational issues, much in the same way that management consulting firms help organisations improve their performance. Crucially, however, while management consulting firms may advise on client’s business projects, investment banks may also provide financial backing for their clients. Regardless of the type of financial service provided to clients, investment banks play an important role in raising the necessary capital for companies’ growth and expansion.
How investment banks work
Investment banks utilise various methods to raise capital for a client and/or generate profit for themselves: 1. Underwriting debt and equity securities: with billions of dollars of capital, investment banks have the ability to ‘underwrite’ debt and equity securities (i.e. shares in a company). Put simply, underwriting is the process by which banks or other financial institutions take on financial risk – in this case, the risk of losing capital – for a fee. Unlike private equity firms, investment banks do not invest in the company itself, instead opting to receive a fee, usually derived as a percentage of the total value of the underwritten debt or stock. This way, investment banks only temporarily expose themselves to loss, as the value of the underwritten loan or stock is returned to the bank in addition to the aforementioned services fee. Although private equity firms may also take on financial risk in the form of capital investment, such an investment grants the firm equity, and no additional fee is paid. As investment banks are often able to negotiate relatively high commission agreements, profits are frequently in the billions of dollars. 2. Facilitating mergers and acquisitions: profits arising from helping companies to merge and acquire forms an integral part of investment banks’ profits. Goldman Sachs, the top financial adviser for mergers and acquisitions in 2020, advised on some 197 mergers and acquisitions worth over $405.8 billion USD. In a merger deal, two separate companies join to form one new legal entity. Commonly, investment banks act as a middleman throughout this process, helping to value assets and negotiate the terms of the deal. Similarly, in the process of one company acquiring another (that is, an acquisition), investment banks will help negotiate the terms of the deal. In return for assisting in the negotiation of mergers and acquisitions, investment banks can receive hefty fees, often determined as a percentage of the deal’s overall monetary worth. 3. Financial advisors: in addition to underwriting financial agreements and consulting for mergers and acquisitions, investment banks may also advise and consult for large institutional investors. Investors might, for example, pay a fee to an investment bank in return for advice on a particular deal or trade. In this way, investment banks may return potentially considerable profit without exposing themselves to any sort of financial risk. Through analysing client requirements, market forces, and other historical data, investment banks may advise on clients’ trade deals, although – for the most part – this will not involve financial backing.
No ordinary bank
But how is any of this different from what a normal bank might do? In a nutshell, although investment banks may help to support and broker multi-billion-dollar financial transactions, they don’t provide any of the financial services that a standard commercial bank might offer, including, but not limited to providing home loans, accepting client deposits, and safeguarding assets. Further, investment banks only very rarely deal with individual clients; many of the institutional investors and financial corporations investment banks deal with consist of more than one person. In addition to this, commercial banks don’t offer many (if any) of the capital-raising services found in investment banks. As such, they often don’t negotiate large-scale investments or deals for clientele. Put simply, investment banks provide financial services for large-scale financial transactions, whereas commercial banks provide services for the common population and small businesses.
Becoming an investment banker
Becoming an investment banker isn’t easy. As even entry-level jobs at investment banking firms command six-figure salaries, competition is fierce. Certainly, though, there is no one way of getting into investment banking. With that being said, there are ways to improve your chance of success. For most, the first step to becoming an investment banker is to earn a business degree. Often times, this will come in the form of a bachelor’s degree in commerce or finance. Importantly, investment banks will recruit from top schools, so attending a highly ranked school for business may play an important role. Additionally, gaining an advanced degree (e.g. Master of Business Administration) may help to enhance your likelihood of gaining employment. While completing your chosen degree, gaining an internship is a must – this will give you the opportunity to network and gain valuable experience in the industry. Finally, networking with firms’ recruiters and hiring managers can only boost your chance of success. Every little thing helps!
Summary
Investment banks are specialised banks that engage in capital-raising and advisory-based activities for other entities, such as corporations, governments, and even individuals. Through various different processes, investment banks are able to advise clients on complex financial deals and/or raise capital for clients. Unlike private equity firms, investment banks specialise in generating capital for clients, usually without any sort of long-term investment. Additionally, whereas commercial banks offer services to the general public (e.g., safeguarding assets and managing accounts), investment banks only engage with larger institutional investors and well-established companies. Given the sheer magnitude of deals negotiated by investment banking corporations, the industry remains exceedingly strong – undoubtedly, investment banking firms remain at the forefront of the financial world.