A Clear Answer for "What Is Investment Banking"
Investment Banking 101
Investment banking can be defined as how companies raise capital using debt or new equity shares. If you want to understand the meaning of investment banking well, you have to look at it from the perspective of what investment bankers do. If a business needs to succeed, it has to seek the help of an investment bank to ensure all the financial transactions are carried out in the interest of the business.
Investment Bankers Have the Following Roles:
They help with managing all the financial transactions in a company. These transactions are those involved in the pitching process to the stage where a contract must be signed.
They help companies with raising funds through debt and equity offerings.
They create various financial models that help companies determine the advantages and disadvantages of engaging in a particular merger and acquisition.
Investment bankers involve themselves in regular research of businesses or potential clients that might need their assistance.
They use various methods to calculate the valuation of a business. Among the techniques used are leveraged buyouts, discounted cash flow, and transaction comps.
Given the above roles of investment bankers, investment banking can be defined as:
The field of investment banking is highly competitive. Therefore, people seeking to have employment opportunities in this field require high levels of experience, educational qualifications, and other essential professional qualifications. Companies seek to employ the best investment bankers because their role in the company is key in determining the company's success.
For instance, if a company does not raise enough funds, it will be unable to finance its operations, thus making it challenging for it to prosper. Also, if a company gets involved in a merger and acquisition with the wrong party, it could contribute to its ultimate failure.
When Do Companies Need Investment Bankers?
You already know the role of investment bankers and the meaning of investment banking. Therefore, most of the reasons and times when a company will need the services of an investment banker are obvious.
One of the common times when a company will require the services of investment bankers is when it needs to manage its finances. Investment bankers have the expertise required to ensure that the company has engaged in financially beneficial activities. For instance, if the company wants to carry out an investment that requires a huge amount of capital, the issuing of stock, or seeking to develop new technology, investment banking will be highly essential.
A company needs to make plans to ensure a steady cash flow. As mentioned earlier, without a steady cash flow, the company will have challenges financing its activities, thus leading to its failure. Therefore, it has to hire an investment banker at any given time to facilitate the process of ensuring a steady cash flow.
What Products Do Investment Banks Offer?
Investment banks use equity and debt to raise capital for companies or individual clients.
DEBT
Debt is issued through the sale of corporate bonds to various investors. The money raised by selling the bonds is then used to finance corporate activities. In turn, the investors receive a certain amount of return on their investment for a specified number of years.
Once the term of the bond is over, the company returns the principal amount to the investors. The investment bankers help by ensuring that their clients sell the bonds to qualified investors that can be obtained using the bank’s network of capital sources.
EQUITY
Investment bankers also help clients to raise capital through the sale of equity during the company’s initial public offering (IPO). Before an individual can purchase shares in a company, they need to carry out extensive research regarding the company’s operations and success rate. If the company is highly likely to succeed, the chances are high that potential investors will buy the shares. An investment banker helps in this process by finding potential investors that are willing to buy the shares at a particular price per share that suits the firm’s needs. They also ensure that the shares meet the investor’s expectations in terms of the return on investment.
Now that I have provided a detailed explanation of how investment banks raise capital for their clients, let us look at some of the products that they offer. These products are offered using the two methods, debt or equity.
Bond underwriting
Investment bankers help companies to determine the maturity and yield of their bonds. This information is crucial because it helps the companies know the amount of money that can be raised using the bond and how it will be repaid. In most cases, the investment banker will purchase the bond from the company.
This purchase is known as the commitment underwriting, and it acts as an assurance that the investment banker will help the company raise capital. The bank might also decide to sell the bonds by itself by contacting some investment bankers it knows will offer the bonds to the public.
Bonds can be sold in the primary or the secondary market. The primary market is where the bonds are directly sold to the investors by the bank. In this case, the proceeds of the bond are paid to the issuer of the bond. The secondary market is whereby the bond is sold to another investor by an existing investor. The proceeds of the bonds sold in this market are paid to the investor.
Equity underwriting
Investment bankers make it possible for their clients to get financing from the capital markets. This is achieved through the sale of equity, whereby the investment banker underwrites the deal to reduce the risk involved. They buy the securities from the various issuers and sell them to the public or other institutions to manage the risk involved.
Investment bankers often purchase securities and increase the sale price to make profits. It is such profits that cushion against the risk involved in the transaction. In other cases, the investment banker can work with other bankers to further reduce the risk involved. Investment bankers are mostly paid in commission terms depending on the number of securities that they sell.
The management of the initial public offering
During an IPO, a company ought to generate offering terms that will attract potential investors. It also needs to define the risks involved before deciding whether it should pursue the decision or not. The investment bankers are responsible for carrying out these activities because they have a lot of knowledge regarding the market and IPOs. They also help the company set a desirable price for the particular offering. If the IPO is not priced at a desirable price by potential investors in the market, the whole exercise might fail.
If the price is set too high, the public might not be interested in buying the shares. If the price is too low, the offering company will not generate enough revenue to pay the return on investments. Therefore, a company has to engage an investment banker to ensure it is making a reasonable decision.
Pricing of the new bonds and stocks
A new issue is registered security that the company has already issued and is ready for sale. The new issue can be either debt or equity, but the most common type of new issue is an initial public offering (IPO). The new issues are mostly bought by new investors who facilitate a push-up in the sale prices. The new issues are considered as a loan that the company obtained by selling bonds. The money is then used to finance profitable organizational activities. Part of the profit obtained is then used to pay the investors their return on investment.
Mergers and acquisitions
Whenever a company wishes to participate in a merger and acquisition, it has to weigh the decision’s advantages and disadvantages. If the merger and acquisition offer more disadvantages than advantages, then it is not worth pursuing. Investment bankers play an important role in investigating the factors surrounding a merger and acquisition to determine its costs and benefits to the client.
Among the activities carried out by the investment bankers are to determine the value of the company that the client wishes to acquire or merge with. The client then uses this value to determine how it would benefit by pursuing the decision. Also, when a company is listed for sale, the investment bankers would evaluate its value to determine the price at which the company should be sold. The investment banker also evaluates the different offers received to determine the best option.
How Do Companies Choose Investment Bankers?
- Experience In Banking
An individual's experience in banking plays an important role in determining how well they will offer investment banking services. While working in a bank, the individual would have experience of dealing with corporate clients. This means they will have minimal challenges in finding and convincing potential investors to purchase their bonds. They will also have access to the financial management processes and the analytics tools used by investment bankers to carry out their job. Therefore, hiring an investment banker with banking experience is an added advantage to the company and makes it easy to raise capital by issuing debt and equity.
- Investment Management
An investment manager plays an important role in ensuring that companies can effectively manage their finances. Investment bankers with experience in investment management have a lot of knowledge regarding the financial management process. Therefore, they are in a better position to lead the company in the right direction in the acquisition of capital.
Investment bankers can also use most of the tools used in investment management to make the right decision for the company. These tools can be used to price new bond issues, determine the risks involved in an investment opportunity, and calculate the value of potential acquisitions. - Team Leadership
An investment banker should have the qualities of a good team leader. Investment bankers work with various clients, potential investors, and third parties, and therefore, they need to be able to manage such teams. A company should look for an investment banker with professional certification in leadership and one who has done tasks in the past that involved leadership. These qualities increase the investment banker’s ability to carry out effective financial work in the company.
- Experience In Mergers And Acquisitions
Planning a merger requires a lot of expertise and is time-consuming. A merger is a decision that can negatively or positively affect a company’s success rate. Therefore, it has to be precisely planned to ensure that it does not negatively affect organizational growth. An investment banker with a lot of experience in dealing with mergers and acquisitions is the right individual to hire for a similar task.
The investment banker should be aware of the current market trends, understand the various bidding strategies and processes and know how to perform financial analysis. These skills would be helpful regardless of whether the investment banker is working for the company being merged or the one acquiring the merger. - Administrative Skills
Apart from the main tasks of an investment banker, they might occasionally be required to arrange trips, make meetings, print documents, prepare notes and perform other administrative tasks. Therefore, they need to possess administrative skills to ensure that they fully satisfy their client’s needs. If they are dealing with potential investors, they need to show the investors that it is worth buying shares or bonds from the client. It is important to create trust between the client and the investor. This kind of trust can be created by the investment banker.
What Is the Investment Banks' Hierarchy?
Investment banks have a hierarchy whereby every rank plays an important role in the activities carried out by the organization. Regardless of the variations in hierarchies among investment banks, the roles are consistent. This consistency plays an important role in determining the reliability of any investment bank in raising capital for companies.
The ranks in investment banking include the following in descending order.
Managing Director
This is the topmost rank in investment banking, and the managing director is responsible for the organization’s profitability. The managing director should also know the economic and political trends that might affect the functioning of the bank.
Senior Vice President
A senior vice president is also known as the director. The position is usually occupied by people who have worked in the bank for many years. It is rare for this position to be occupied by an individual who has not been working in the bank. The director is the link between the client and the employees in the lower ranks.
Vice President
This rank is achieved by investment banking associates after working in the field for three to four years. Their role is to speak to clients and offer them updates on the progress in different transactions. They supervise the analysts and associates.
Investment Banking Associate
This rank is achieved by analysts after working for two years in the industry. However, if an individual has a graduate degree from an MBA program, they can join this rank without necessarily working as an investment banking analyst. The associate has the role of talking to clients to find out more about their needs.
Investment Banking Analyst
This is the lowest rank in investment banking, and it includes fresh graduates from different business schools. The analyst has to work at this rank for at least two years before progressing to the next rank. They perform tasks such as creating PowerPoint presentations, building financial models, and researching companies’ information.
Summary Of Investment Banking
Occasionally, companies will need to raise money to finance their operations. The easiest way through which such money can be raised is through the issuing of bonds and equity. However, the process might not be easy because there is the risk of investors not being willing to purchase the bonds and the shares. This is the part where a company needs the services of investment banking. Investment banking has the necessary skills to ensure that it facilitates the process through which companies acquire capital.
An investment banker has all the resources to evaluate a company’s value and to connect its clients with potential investors. In the case of bond issuances, investment bankers play an important role in reducing risk through underwriting. If you run a company that wishes to acquire capital through bonds and shares, it is important to hire an investment banker to make the process an easy one. Investment banking plays an important role in the world of business, and companies will, at some point in their lifetime, require their services.
If you wish to pursue a career as an investment banker, experience is one of the key factors that will determine how easily you obtain clients. Most of the clients are looking for investment bankers with experience in the banking industry, mergers and acquisitions, and investment management. Investment bankers with such experience find it fewer challenges to help clients with acquiring capital. Therefore, you will need to gain experience in these fields to increase your chances of being hired by clients. You will also need to get the right educational qualifications and additional certifications that will increase your knowledge base.
Wealthry Helps You Become a Financial Superstar!