The four main areas of investment banking activity are capital markets, advisory services ( M&A and Restructuring ), trading & brokerage and asset management.
Capital markets – raising equity and debt capital
Capital markets are one of the most fascinating areas of investment banking. Companies need this services when they are about to go public or want to issue debt sold to the public.
When a company wants to raise equity we talk about ECM ( Equity Capital Markets ) and when it wants to raise debt, we talk about DCM ( Debt Capital Markets ).
Going public is a critical moment in the life of any company. This means it has grown from a small business to a big entity ready to have public investors abroad. The company shares will be sold to public investors which will be able to decide on the board of directors. As this process is very complex, investment banking firms provide advisory on these matters.
There needs to be a balance between the amount of shares to be sold and the right price. Founders are only willing to be public if these conditions are met. Meanwhile, public investors are interested in growth companies with great management and high potential.
The company will also be required to file their documents and financial statements to the public, which increases their costs on employees and other needed services. Private firms are not forced to comply with these terms.
The right time to go public
Timing places a critical role in an Initial Public Offering ( IPO ). The company must be ready in terms of size, profitability, administrative capacity, growth potential, and investors must be convinced that their money is in good hands; solid management.
What is the investment banker’s role in this process?
Historically, investment bankers have been the trusted advisors for companies who ensure that the whole process goes smoothly.
They provide guidance on when it’s the right time to go public, how the company can position itself to attract investors interest, to organize meetings between the companies management and investors and to present to investors the investment opportunity.
In addition, investment bankers build lists of investors intentions and determine what will be the price at which the company will sell its shares.
Ultimately, after the IPO, investment bankers will exercise certain instruments to stabilize the price of the stock in the first few days.
Issuing more shares is an easier process than an IPO. We refer to the process as SEO ( Seasoned Equity Offerings ). It is easier because the company is already listed in the stock market, their shares already have a price and the organization is already compliant with requirements for listed firms.
In this case, the role of investment bankers is limited to finding investors and participate in the company’s increase of capital. They will underwrite the stock once sufficient demand has been established.
Debt Capital Markets ( DCM ) are the second main pillar of underwriting services. Besides equity, corporations can issue debt in form of bonds. The process and instruments are similar, as are the players. However, there is one main difference; bonds can be issued by sovereign countries.
A company, or government, can borrow from public investors too while public debt markets work efficiently.
What is the investment banker’s role in this process?
Investment bankers would in this scenario, advise the loans terms, prepare the company’s presentations, find potential investors and price the loan.
On average, bonds are much easier to price compared to equity. Mainly because every company that issues a bond has a credit rating expressed by independent credit rating agencies
Another form of DCM services are the loan syndications. These are loans granted by a pool of banks. Usually several banks get portions of the loan. Such groups of banks is called ‘The Syndicate’.
Syndicated loans are a hybrid between bonds and commercial banking loans. There are several reasons a bank might be interested in loan syndications; diversification, fee generation and new geographic opportunities.
Advisory services – M&A and Restructuring
M&A (Mergers and Acquisitions) services became increasingly popular in the 1960s, when a bunch of conglomerate buildups took place. The main investment banks understood this line of business can be profitable, because M&A Deals occur multiple times, while IPO’s are a one off event.
An acquisition occurs when a company buys another company’s assets or shares. We have a merger when the buying company absorbs the target company and the target company seizes to exist (it is merged into the buying company).
In every M&A process there are at least two parties; the buyer (the buying company) and the target company (company to be acquired). The buyer can pay the Target’s shareholders in several ways; cash compensation, stock package of the new entity or a combination of both.
Top managers understand that sometimes it’s cheaper to buy something that has already been created rather than creating something new. In addition, businesses are so complimentary that their combination can unlock a great deal of savings, efficiencies and opportunities.
Why do companies need help when acquiring other companies?
Investment bankers are ideally positioned to provide valuable M&A insights to their clients as they know their business and the industry in which they operate.
For example, being able to find bidders or targets, communication systems and negotiation with legal, technical and financial know-how. Even some of the large firms do not have the scale to scope with the issue of these problems.
In any transaction there are two possible roles that an investment banker can have; they can be buy or sell side depending on who hires them. Banks prefer to be on the sell-side as a transaction is likely and commissions are almost guaranteed. Buy-side investors get paid in a more complicated way, as they receive a retainer ( a fixed amount which covers their costs ) and a success fee only if the client buys the Target.
Focused on finding a large number of bidders, prepare the organization for all questions asked by buyers, make a valuation of the business and suggest a minimum bidding price. Sell-side is also responsible to coordinate the entire sales process.
Mainly responsible for providing strategic advice on the Target, provide a business valuation and estimate the amount of synergies between both companies.
The success of an M&A Deal is determined by the price the buyer pays to the seller.
Restructuring services are necessary when a firm is in danger of going bankrupt. It is very complex to help businesses when they are in trouble.
Sometimes, corporations borrow money to solve operating difficulties ( core business ), or financial difficulties ( e.g. cash flow ).
The two main alternatives are a private workout and the bankruptcy procedure. A private workout provides a business with fast results and a higher recovery rate. Investment bankers create therefore a restructuring plan.
Trading and brokerage – trading with financial securities
Trading and brokerage consists in purchasing and selling securities by using an investment bank’s own money ( proprietary trading ) or doing it on behalf of its client ( brokerage ).
These are two of the core activities carried out in modern investment banks. Trading & Brokerage accounts for 35% to 50% of revenues of pure investment banks ( Morgan Stanley and Goldman Sachs ). There are very few costs related to the revenues it generates.
Banks are profitable in the business of buying securities with their own money and selling it later to a profit due to their knowledge and ability to pick profitable trades. Their research department is helpful in creating strategic planification.
Investment Banks play a very important role for the liquidity of financial markets. Very often they support the trading of less liquid securities by applying a market-making technique which consists in buying a small number of securities and being ready to sell these securities to customers when they place an order. A spread is earned for providing this service.
Besides the traditional asset classes (equities and fixed income), IB’s tend to be active with derivative contracts for hedging purposes or for speculative reasons. For example; forwards, futures, options and swaps.
Asset management – the ability to use money to make more money
Asset management is about managing clients investments and providing them with strategies and expertise that would allow them to achieve their goals and secure their financial future. In other words, asset managers use money to make more money.
An individual or corporation will approach an asset manager when their income from investments is substantial. Asset managers can provide insights into; stocks, bonds, commodities, real estate, private equity, etc. Moreover, large banks have branches all over the world and are able to offer geographical expertise as well.
Therefore, they are useful to get substantial investment returns due to their methodological process. First, client needs are studied, then an investment strategy is created, implement the strategy and oversee its development through time.
BRIC country stocks
Different types of stocks can be included, depending on the risk of a client’s profile.
At the end, an asset managers solves the following problem: How to allocate a client’s money?
Their main goal is to maximize returns and minimize risks.
Asset Management Divison
The Sales Force ( establishing relations with clients ).
The Portfolio Managers ( responsible for making investment decisions ).
The research department.