Investment banking: demystifying the jargon in the corridors of corporate finance.
Arti Samant, whose Kitchen Accessories Company is becoming a name to reckon with in the startup circles, feels overwhelmed to figure out how to keep control on her finances. She started selling aprons and chef hats and gloves as a hobby but it soon became famous after celebrities who shopped there featured her on their social media. Orders started pouring in and the income, it grew exponentially.
She even hired senior management teams to streamline business flow and finances. Arti is ambitious. She didn’t want to stop there. “How do I make this bigger?”, she wondered.
Get funding, suggested someone.
Collaborate with another company said someone else.
That’s when her when her cousin’s husband who worked in an investment bank stepped in. “Arti, why don’t you come by to our office and let me and my colleagues explain to you what we can do for you?”, he requested.
What is investment banking?
As the name suggests, Investment Banking is about managing investments for a bank’s clients that offers such services. These services can be availed by high net-worth individuals, corporations and even governments to plan and manage large projects, saving them time and money by identifying risks associated with the project before they move forward.
Investment Banking – the definition
To define in the simplest sense, Investment Banking refers to a highly specialized segment within banking operations that helps raise capital and provide financial consultancy services pertaining to large, complicated financial transactions.
Traditionally, the services may include a through investigation, analysis and informed recommendations about how much a person or company is worth. Basis the results, professional investment bankers will determine whether or not it merits consideration for a deal. Investment bankers will further structure an optimally profitable deal if the client is considering an acquisition, merger or sale.
When Arti visited the Investment Bank, she inquired about the various departments and operations under this umbrella.
Most investment banks maintain prime brokerage and asset management departments in conjunction with their investment research businesses. As an industry, it is broken up into the Bulge Bracket (upper tier), Middle Market (mid-level businesses), and boutique market (specialized businesses).
What are the various advantages of engaging Investment Banking?
When she sat with the team of investment bankers, they explained to her briefly the advantages –
• By the very virtue of its name, an investment bank that handles these clients effectively invest their money in other companies to create more value for it.
• Second advantage would be to help these investors raise the required financial capital by underwriting or acting as an agent in the issuance of securities to conduct this acquisition, merger or sale.
• The third major advantage of investment banking is a though investigation to ensure every compliance is met for its client’s deal thereby minimizing any risk of failure or loss of invested capital.
What are the various types of Investment Banking?
Within an investment banking division, there are typically two kinds of operational divisions: product and industry. The most common product groups are
• Mergers and Acquisitions (M&A),
• Corporate finance (Financial Restructuring and Leveraged finance)
• Equity research
• Sales & trading, and
• Asset management
Mergers and Acquisitions (M&A)
Merger, as the name suggests a collaboration between two or more companies to form a new entity with a common corporate purpose and streamlined financial goals.
Acquisition on the other hand, very commonly refers to a high net worth company or individual or a group buying off a company in parts or whole.
Mergers and Acquisitions (M&A) are often grouped as a deal-making provision within the realm of investment banking. Banks advise buyers and sellers on business valuation, negotiation, pricing and structuring of transactions, as well as procedure and implementation. One of the most common analyses required to be conducted for any M&A deal is the accretion/dilution analysis, while an understanding its accounting, the rules for which have changed quite significantly over the last few years as the markets evolved and expanded. Other services within the realm of M&A include advising clients on joint ventures, hostile takeovers, buyouts, and takeover defense.
Investment banks also provide “fairness opinions” – documents attesting to the fairness of a transaction.
Corporate finance will allow you raise capital for your current and future needs by analyzing their current net worth, repaying capacity and growth projections. This can be done via products like loans, underwriting, raising IPOs (Initial Public Offerings), etc.
When a company is facing a financial challenge, a more specialized subset of Corporate Finance such as Financial Restructuring and Leveraged Finance can come in handy.
Financial restructuring is the process of reshuffling or reorganizing the financial structure of an organization. It primarily consists of equity capital and debt capital. Restructuring bankers serve troubled businesses that are facing, coping with or recovering from bankruptcy. They help a company modify its debt, structure or operations.
Leveraged Finance is a further specialised area within the investment banking division of a bank that is responsible for providing advice and loans to private equity firms and corporations for leveraged buyouts.
“I hope I never need that”, thought Arti.
What are the different types of Investment Banking products?
An investment bank may provide ancillary services such as issuance of securities, underwriting, sales and trading of derivatives and equity securities, and FICC services (fixed income instruments, currencies, and commodities).
Issuance of securities is a means of raising money for the client or group of clients and creating the documentation for the Securities and Exchange Commission, which is a prerequisite if a company is planning to go public.
Underwriting is essentially the investment bank standing guarantee for the loan that has been given to a corporate or individual for business purpose that is clearly defined. Investment banks also underwrite IPOs in an assurance to the investing public that they have investigated the company’s credibility and is good to invest.
Sales and Trading of derivatives and equity securities is a highly specialized skillset offering where accurate data and its analysis is used to gauge the market price of stock and its potential to grow or fall. These skills allow registered traders to buy and sell stock for their clients.
FICC services comprise of handling fixed income instruments, currencies, and commodities that unlike stocks carry a lesser risk of every day market performance as the percentage of growth is far more steadfast.
What are risks associated with Investment Banking products?
Investment banking involves finances that are dependent on many, many factors; some expected or unexpected events either in the over all economy or the financial markets. Risk can also arise from erroneous oversight or foul intention, which causes erosion in asset values and, consequently, reduces the bank’s intrinsic value.
Eight types of bank risks
• Credit risk (relates to the creditworthiness of the company that the bank invests in)
• Market risk (relates to the performance of the financial markets)
• Operational risk (relates to operation process flows and glitches in due diligence)
• Liquidity risk (some stocks show great value but depreciate when liquidated)
• Business risk (the company might have unexpected setbacks that affect its net worth)
• Reputational risk (related more to the history of the individuals or promoters of the company)
• Systemic risk (these are as the name suggests, systemic and operation related)
• Moral hazard (unlawful and unfriendly practices such as ethics, etc.)
All banks set up dedicated risk management departments to monitor, manage, and measure these risks.