Quick Question: What is Investment Banking?

Any undergraduate student entering business school understands the uncertainty that comes with being asked the question, “What kind of business career do you want to pursue?” If you’re someone like myself, with little to no prior knowledge of any of the business disciplines, you’ll do your best to sound confident and muster some response along the lines of, “consulting sounds interesting, but I think investment banking is the place for me”. Say that enough times and it predisposes you to start pursuing investment banking as a field of study. Now, I find myself prepping for the accelerated Investment Banking recruitment timeline and feeling rather proud of myself as I begin to lift the the cloud of mystery around the infamous business buzzword that is investment banking. That is until I found myself asked the question, “what is investment banking?” After a series of spluttered attempts at answering, I realized that while I was learning the basic responses to questions that could be asked during a technical interview, I lacked a broader understanding of how the system operates as a whole. That led me to reaching out to one of my peer mentors and doing some outside research for myself to answer the daunting question, what is IB?

What Does an Investment Bank do for its Clients?

We can generalize the services that an Investment Bank can offer its clients into three basic groups.

  1. Advice on how to raise, invest, and manage money
  2. Aid in the management and release of a client’s bonds and shares.
  3. Advice on how to acquire or merge with other organizations.

Let’s unpack these categories one at a time.

Raise, Invest, and Manage Money

If a client needs money, an investment banker will find organizations with money to invest and advise their clients to do one of two things: issue debt or sell equity. In issuing debt, a company will borrow money from the providing organization and pay that sum back with interest over time. The principal quantity borrowed is known as a bond and when the providing organization purchases the bond (or gives money to the Investment Bank’s client) they become investors. If a client is to sell equity, also known as issuing equity, the company is selling a portion of their business. Each measurable unit of business sold is called a share and the value of that share increases or decreases depending on the success of the business. This provides incentive for organizations to invest as there is potential profit to be made.

Managing Securities

Bonds and shares together are known as securities and are exchanged on the stock market. Investment bankers help manage the release of these securities and advise their clients on the complex nature of things like interest and exchange rates. When a client decides on what kind and how much of a security to issue, an investment banker and his/her team will come together to create a Prospectus which is a brochure that advertises to potential investors why purchasing the client’s securities are in their best interest. When the client is happy and the regulators satisfied, the securities are sold and can be exchanged on the stock market.

Mergers and Acquisitions

Investment bankers also provide their expertise to clients looking to expand their business and become more profitable through the process known as mergers and acquisitions. In a merger, a company combines with an organization to share customers and assets creating an entirely new entity. In an acquisition, a company purchases a smaller organization and absorbs their assets into the existing organization. Due to the complex nature of combining two firms, investment bankers on both sides of the deal work in large teams to make sure all goes smoothly. Information regarding mergers and acquisitions must be kept top secret until publicly released because news of a deal may impact how an investor feels about owning securities (stocks/bonds) in the business.

It’s important to note that this is a very general outline of the services an Investment Bank provides its clients. Let’s take a deeper dive to better understand the internal structure of an Investment Bank and the more complex business operations that are performed.

Product vs Coverage Groups

Investment bankers are often split into two categories, coverage and product groups. Being in a coverage group, means you specialize in a particular market industry and work on variety of financial deals within that market. Industry groups commonly include: Consumer Products & Retail, Energy & Power, Financial Institutions, Manufacturing, Healthcare, Global Industrial Groups, Real Estate, TMT (Technology, Media, and Telecommunications), and Utilities. Product groups, by contrast, specialize in a particular financial service and perform it across industries. The major teams on the Product side, Debt Capital Markets, Leveraged Finance, Equity Capital Markets, and Restructuring. Product groups often seem a little intimidating at first glance, so let’s explore them a little further.

Debt Capital Markets & Leverage Finance — Both of these product teams serve similar functions, but work with very different clients. Across both products, bankers help their clients raise debt capital primarily through bond issuances. The clients for Debt Capital Market teams are “investment grade,” which means they have high enough credit ratings that investors will see them as low risk and safe investments. Leverage Finance teams, by contrast, work with “below investment grade” clients. These companies are considered to be less stable and consistent and may have higher amounts of pre-existing debt. The benefit is that loaning to a below investment grade client allows for higher interest rate and greater potential profit.

Equity Capital Markets — In this product division, bankers help their clients raise cash through the sale of equity in their business.

Restructuring — On this team, bankers are working with clients in different stages of debt, either facing the prospect of, coping with, or recovering from bankruptcy. The role of the investment banker in this product is to work as an intermediary to help the clients pay off their creditors and debt holders.

Mergers and Acquisitions — In M&A, investment bankers advise and seek out potential candidates for clients looking to buy or sell their company. They handle much of the modeling and technical aspects of the deal and ultimately come up with a fair price for the transaction.

Across different business deals, coverage and product groups will work in tandem to provide their joint expertise to best service their clients. It is also important to note that not all banks have both product and coverage groups, for more information regarding that please refer to,“Banking at Michigan — Types of Banks”.

Regardless of product or coverage group, an investment banker’s primary driver is to do best by their client in a timely and precise manner. Being an investment banker means being the middleman of the buying and selling of a company and embracing the intersection of technical knowledge and human relations.