Everything You Need to Know About Investment Banking: What It Is, How It Works & More
By Vladana Donevski
June 19, 2023
When most people think of banking, they probably imagine services like checking and savings accounts, mortgages, and car loans. However, there is another type of banking that is quite different: Investment banking. Bankers from this branch work in the securities industry and assist companies with increasing revenue by issuing and selling securities.
This article will discuss the definition of investment banking, how it works, and present some examples of this financial undertaking in action. Read on!
So, What Is Investment Banking?
Investment banking is the process of helping companies raise money by issuing and selling securities. This can be done through various means, such as initial public offering (IPO), secondary market offerings, and private placement.
This type of bank also helps companies with mergers and acquisitions (M&A), which is when two companies come together to form a single entity or one company absorbs another, respectively. One company can purchase another’s securities through asset sales, stock sales, and cash mergers.
Last but not least, the corporate investment banking division can also help companies with restructuring, which is when a company attempts to improve its financial situation through debt and equity restructuring, or corporate reorganization.
In short, investment banks and their bankers are the places companies, governments, and high-net-worth individuals turn to for guidance with significant transactions. These institutions can provide businesses with much-needed advice on progressing with financial decisions, investments, and fundraising.
Now that you know investment banking’s definition, let’s discuss how it actually works.
How Does Investment Banking Work?
To help you understand better how investment banking works, let’s take companies A and B as an example.
Raising Funds With Investment Banking
Let’s start with company A, which is looking to raise money to fund an expansion into a new state. It has many alternative funding options at its disposal, one of which is an investment bank.
That would mean an investment banker would work with Company A to figure out the type of security it should issue, help with the issuance process, and advise on how to market said security. Further, they would help Company A set up the deal, and negotiate with potential institutional investors.
Once the asset is issued, the investment bank would help the company sell it through stock exchanges, over-the-counter markets, and private placement.
Investment banks will also help the company with post-issuance activities, such as compliance and reporting. Sometimes, the help with staying compliant with securities laws and regulations is the main reason businesses hire an investment bank to handle the process.
Acquisitions and Mergers
In another example, Company A might want to purchase Company B; in this case, corporations usually turn to investment banking services for help.
For example, Company A might not be sure how much Company B is worth and whether the acquisition will pay off in the long run. This is not always an easy question to answer, and this is where investment bankers, with their experience and knowledge of the current market situation, are invaluable. The bank can also advise Company A on the ideal time to commence the deal.
Of course, an investment bank, by definition, will earn more money if the trade amount is higher, seeing as how most of them take a percentage from the transactions they facilitate. Other investment banks may also be working on the other side of this deal, helping Company B sell itself.
Proprietary Trading
Investment banks will often trade by themselves. This in-house trading is often a vital part of their business, as they not only need to generate profit, but also maintain stability. Therefore, this proprietary trading is always calculated, aimed at growing capital needed for expansions or development, without putting any current assets at risk.
Now that you know the answer to “What is investment banking?” and how it works, let’s look at some examples.
Examples of Investment Banking
The most common processes investment bankers participate in are Initial Public Offerings, secondary market offerings, and private placement investment banking. The investors could be venture capitalists, private equity firms, or even hedge funds.
An IPO is when a company goes public for the first time – i.e., makes its shares available for purchase for the first time. A secondary market offering is when an investor makes their company shares available for purchase. As you can see, both are part of investment banking, but the process is different.
An investment bank will typically serve as a proxy for selling the assets on the market, taking on part of the risk and therefore marking up the stock price for its own commission. After all, the investment bank might lose money if it sells the stock under market value, which might happen, because markets are unpredictable and react unfavorably to indications that the company’s fortunes have changed.
What Is The Difference Between Retail Banking and Investment Banking?
Understanding how investment banking differs from retail banking is based chiefly on the type of clients and level of sophistication.
Investment bankers work with large institutional investors and corporations, while retail bankers work with individual consumers. Investment banking activities include underwriting securities, providing financial analysis, and advising corporate clients. Retail banking activities include providing loans, managing customer accounts, and enabling day-to-day transactions.
Some of the largest banks in the world are investment banks; Goldman Sachs, JPMorgan Chase, and Citigroup all fall into this category, and they provide their services for mergers and acquisitions, capital markets, and private equity trading.
In Conclusion
Now you know what the investment banking industry is and how it works. It’s a vital part of the corporate finance world, so it’s essential to understand it – especially if you have just started your new business and are looking for funding. Thanks for reading – we hope this article was helpful!
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