What is it?
So, what is investment banking and what do investment banks do?
Investment banks are financial institutions that help companies or governments raise money (aka capital), as well as advise them on other important financial decisions, such as mergers and acquisitions (M&A) or bankruptcy restructuring. Let’s explore each one of these functions in more detail.
Raising Money (aka Capital)
In short, investment banks connect institutions that need money with investors that have money. This money can come from investors in the form of equity (stocks) or debt (loans and bonds), depending on what makes most sense for the company.
Imagine you’re a CEO of a big company and you want to build a new manufacturing facility to meet the demand for your highly-desirable product. The manufacturing facility will cost you $500 million, but you don’t have that kind of money just sitting around. It is also unrealistic to think that any one of your friends has $500 million to lend to you when you need it (unless your best friend is Bill Gates or Warren Buffet).
So this is where investment banks come in – they help companies find many different people (investors) who will contribute smaller chunks towards that $500 million that you need, and they take care of all the necessary work that needs to get done in the process (e.g. putting together presentations, valuation, legal documents, etc.) in order to make both the company and the investors happy at the end of the deal.
Mergers & Acquisitions (M&A)
When Company A wants to buy Company B, it needs to figure out if it makes financial sense to make the purchase, at what price, and what the best way to finance the transaction is (how to pay for it). This is where the M&A group of the investment bank comes in, advising their client (the company) throughout the process.
A merger basically means that two companies of similar size come together to become one bigger company (with roughly 50/50 ownership). On the other hand, an acquisition is a very similar concept, but instead of two companies merging together, Company A buys Company B (and becomes the owner of the combined company).
M&A bankers do a ton of analysis to find companies that would be strong potential targets and exploring if the deal would make sense. If a company seems like a good fit for a merger or an acquisition, it is important to see what the financial impact is for the company entering the deal. This means that the bankers prepare a set of financial statements projecting what they would look like after the deal is done. On top of that, M&A bankers have to be familiar with legal issues behind the deal as well. Otherwise, both the company and the bank might run into a lot of problems down the road.
As you can imagine, these are very complicated transactions that must be executed very carefully. M&A groups consist of experts that have the necessary knowledge to guide a company through this complicated process, and to make sure that all parties involved are happy at the end of the deal process.
For example, imagine that a company has borrowed and spent $500 million to build a manufacturing facility, but now it doesn’t have the money to pay it back.
These types of situations are some of the most difficult ones in the business world. If you’re an investor who contributed towards that $500 million, you want to get your money back. However, the company doesn’t have anywhere to pay you from. So what do you do?
Restructuring groups are the ones who deal with these types of situations as they try to resolve the issue by reaching an agreement between the company and the investors. These restructuring deals can be extremely complex, and typically take much longer than any other type of deal (sometimes lasting several years). The goal, of course, is to make everyone as happy as they can be (given the unfortunate scenario) by the end of the process.
Other Functions of Investment Banks:
- Market makers (facilitate trading) for vast array of securities – Sales & Trading
- Provide research on companies they cover for clients – Research
All in all, investment banks are essential for companies to deal with any large financial decisions (such as raising money, buying or selling a company, restructuring debt, and so on). These processes are so complex that the companies would not be able to do them on their own. Even if they did, they would probably do a bad job and at a much higher cost.