Investment Banking: Definition, What They Do – Business Insider
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Unlike retail banks , which can work with individual consumers on offerings like deposits and loans, investment banks are a special kind of financial institution that help companies, governments, and institutions raise capital.
„If you want to borrow money for a home purchase, when you go to the bank, they’re connecting people who have savings in the bank [with] borrowers,“ explains Emil N. Siriwardane, Finnegan Family Associate Professor of Business Administration at Harvard Business School. As he notes, investment banking basically does that function for companies.
These banks have been around for a while. Early investment bankers have been said to begin as merchants trading commodities like spices and cotton. These merchants then could facilitate product production and transportation.
Speeding forward a few centuries, into the 19th to be exact, the term „investment bank“ became more popular. Global firm JPMorgan Chase & Co. even traces its roots back to 1799 in New York City, pointing to what it calls „heritage firms.“ And early investment banks raised capital through actions like selling railroad stock and organizing company buyouts.
To raise capital, investment banks act as advisors and intermediaries between corporations, other entities, and investors. These banks can specialize in areas like mergers and acquisitions, underwriting, private equity, and venture capital.
Bankers even can focus on specific sectors, like health care and tech, as well as sectors according to size, notes David Erickson, a senior fellow and lecturer in the Finance Department at The Wharton School and co-director of the Stevens Center for Innovation in Finance.
Quick tip: Just remember, investment banks act as intermediaries between entities that want to raise money and the individuals and entities that offer it.
When it comes to classification, so-called „boutique banks,“ including regional boutique banks, can be smaller and more independent. They also can focus on specific sectors of investment banking, notes Erickson. Meanwhile, „bulge banks“ include large global firms with easily recognizable names. Think Goldman Sachs, JPMorgan Chase & Co, Morgan Stanley, and more.
Also know: An investment bank is not the same thing as an investment banking division. Full-service investment banks can offer a wide range of offerings that include underwriting, M&A, sales and trading, and equity research. Meanwhile, an investment banking division of a bank provides underwriting and M&A advisory services.
Investment banks can employ a variety of people, and there is a hierarchy. Employees can include investment banking analysts, investment banking associates, vice presidents, directors or senior vice presidents, and managing directors.
These staff members work on a variety of projects and deals and can work long hours. But these professionals also are highly paid for their skills, with annual rates in the six figures possible for junior staff and into the millions for senior staff. And the work can be rewarding both personally and professionally, notes Erikson.
Investment bankers also can work on different kinds of projects. „Banks help companies that need money get it,“ says Siriwardane, noting that, within that structure, there are different ways banks will raise money.
„A typical investment banker will have a group of companies that they work with,“ Erickson adds. And then they’ll figure out what companies need and consider potential funding sources.
Quick tip: Investment banks can use a variety of strategies to raise capital, and they may even combine strategies to get the best results.
These financial professionals can provide many different services:
Equity financing. This capital-raising process can include private equity, which is private financing, such as capital from a high-net worth investor or firm. Venture capital investments, which can be popular for start-ups, are another way to secure equity financing, as shareholders finance companies in exchange for an equity stake. Investment banks can serve as intermediaries to connect companies to private investors or venture capital, or to oversee the process of offering shares to the public in an initial public offering, or IPO. If you’ve ever bought stocks or been interested in the stock market, you may remember how companies like Facebook and Google raised billions of dollars in capital via IPOs. With this kind of financing, companies can share their profits with investors and consult them on decisions.
Underwriting. For this function, investment banks can work between investors and companies that want to raise money or go public. This process involves doing research and assessing risk, and then the investment bank prices, underwrites, and sells the new securities. Investment banks can profit on the difference between the price paid for the securities and what securities are then sold for. Underwriting can involve a bank taking a financial risk in the project as well, for a piece of the pie. For instance, when investment banks offer underwriting, says Siriwardane, they can, in some cases, arrange for debt to be picked up by investors but keep a bit of the debt themselves to have „skin in the game,“ typically for a very specific kind of debt.
Debt financing. For this process, investment banks will help companies borrow money, such as a loan. Then companies agree to pay back the money over time, with interest. This process is different from equity financing because the lender has no ownership of the company it is funding and, thus, does not typically have a say in business decisions. When the debt is repaid, the business relationship can end. That said, this process can create certain restrictions while the company is repaying the debt.
Sales and trading. This work involves acting as an intermediary between buyers and sellers of securities in the secondary market. For this function, banks can work with mutual funds, hedge funds, and more, the Corporate Finance Institute confirms, noting that these trading groups „act as agents for clients and also can trade the firm’s own capital.“
Leveraged buyouts. In this kind of transaction, a company can be acquired using mostly borrowed money, explains Siriwardane. In this way, the buyer — like a private equity firm — can put in some money and borrow the balance to finance the acquisition. Sidwardane likens this company move to when a consumer buys a home using a down payment and a loan. This model can be layered, creates debt, and also has its own risks.
Mergers and acquisitions (M&A). When it comes to this well-known project area, investment bankers can advise buyers and sellers of companies and manage the M&A process from beginning to end. In a merger, two firms combine into a new legal entity. And in an acquisition, one firm buys — or otherwise acquires — another.
„[The M&A process] can get complex quickly,“ Siriwardane says. As part of this process, an investment bank „will help you figure out what price to pay for a firm,“ he adds, noting that the bank must research and understand what drives a company’s profits, how to evaluate costs and general industries, and more.
There can be various ways to structure these transactions, and financing can happen using cash, stocks, or even when one company assumes the debt of another. Depending on the deal, this process can last for months or even years.
When it comes to the work of investment bankers, there’s a lot at stake. As Erickson notes, these bankers need to do their due diligence and help their clients understand the risks taken on with financial transactions. And bankers need to understand and manage the risks their banks are taking on.
Quick tip: Investment bankers must understand the potential risks and benefits of deals for both their banks and their clients.
Plus, relationships matter. „You have to have a very, I would say, consultative approach … Make sure you’re a good listener to understand what the company’s looking to achieve,“ adds Erickson. „And think about different potential solutions that can help them achieve those things,“ he says, as well as doing the work to present pros and cons.
Investment banking is a type of banking that focuses on raising or creating capital for companies, governments, and other entities. Investment bankers are responsible for analyzing trends, assessing risks, providing strategic advice, and managing projects.
If you’re interested in working in this field, it’s important to understand the responsibilities of these banks and the work required to meet business goals. And if you’re interested in raising capital for your own company or entity, it’s important to understand how an investment bank may be able to advise and help manage your project.
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