What Is Investment Banking?

Back when I was a banker, I used to get this question all the time.  In areas outside of New York and maybe Boston, the term was likely to be associated with a gig as a loan officer at the local First National Bank.  Since the fall of Lehman and Bear, and the rise of the Occupy movements, the connotation has become a bit more sinister.

My old standby explanation was that an investment bank was really just a bank for companies.  In hindsight, this analogy was pretty weak – sure, an investment bank might loan money to a company as a retail bank might to an Average Joe, but the comparison falls apart somewhat from there.  (And even that might not be very accurate – depending on the setup of the bank, corporate loans might be handled by a commercial banking team more than an investment banking team.)  For example, a retail bank isn’t going to help a person raise equity (no matter how great of a person the client may be) or advise them on how to acquire a competitor.  Really, the only way to explain what an investment bank is is to go through at least a high level synopsis of the information below (the average listener’s eyes will likely glaze over well before you get to the part about the advisory side of the business.)

At the most basic level, investment banks provide access to the capital markets (equity and debt) to their clients so that the clients can fund and grow their businesses.  Additionally, bankers provide advisory services – most notably advice on mergers and acquisitions, where many of the most famous bankers made their marks.  (Many of the most infamous bankers did so in the debt capital markets in the junk bond era.)  There are many additional ancillary products and services that straddle the invisible line (in banking terms, this usually means a “Chinese wall” is in place to prevent the exchange of private information between groups) between investment bank and corporate bank, or investment bank and “sales and trading” unit.  (Indeed, the majority of the folks that created the CDOs and other derivative products that led to the financial crisis were mostly on the trading side of the business rather than the banking side.) Although the sales and trading units are technically part of the investment bank, our discussion of investment banking will be restricted to the traditional “sell-side” segment that offers capital markets and advisory services.  (“Sell-side” generally refers to these services offered by investment banks wherein the banks/bankers receive a fee for providing service such as advisory work or underwriting capital markets offerings; “Buy-side” generally refers to investment funds that have capital to invest.  Research is another component of an investment bank that operates somewhat with a foot in both worlds – a subject for another post.)

Importantly, an investment bank is a service business – ie one that provides benefits to clients principally via intangible human capital rather than via a physical product.  At the end of the day, senior bankers must possess a strong sales capacity and build relationships with their clients.  An interesting component of the sales process is that the team of bankers is the product, so there is no need for horizontal or vertical integration with a production or engineering team – the senior deal team member will be selling the team itself.  The bankers responsible for cultivating client relationships must constantly reiterate the value of using their particular team, and will frequently provide detailed analyses and “pitch” ideas as a way of keeping in front of the client.

Generally banks are organized such that there is a “coverage” team that works with a specific group of clients in a sector (such as Media, Telecom, Industrials, Financial Institutions, etc) – the bankers in these groups are not experts at any particular “product” however – they will typically have colleagues in mergers and acquisitions (heretofore, “M&A”), leveraged finance or other product areas who will attend specific meetings once discussions or ideas lead down a fairly narrow path with a client.  Usually the product partners work with a much wider universe of clients, but they do not have quite the relationship-building responsibility as the coverage bankers.  (This is not cast in stone, however, as clients sometimes develop a strong rapport with a product partner and come to view them as part of the coverage team – for example if a company has done two acquisitions with the same banking team, they will like become very close/comfortable with the lead M&A banker and make inbound calls directly to the M&A banker.)

In a nutshell, the job of the average bread and butter “coverage” banker is not significantly different than that of any kind of traveling salesperson – spending significant time traveling to see clients, in many cases pitching ideas (somewhat analagous to cold-calling, except it’s the idea that’s being shown for the first time, not the introduction) to foster relationships, with only a small likelihood of advancing the pitch idea beyond the initial meeting stage.  However, every meeting is an opportunity not only to build (or weaken!) the client relationship but to learn information not only about that client but even their competitors and get a better sense for the strategic landscape in that industry. At the more senior levels in banking (Vice President and above) information trafficking becomes very important – demonstrating industry knowledge and that the banker has the right connections.

In summary, investment banks provide services that allow businesses to fund and grow their operations, and strategic and financial advice (such as when to repurchase shares, optimal debt levels, etc.)  We will provide additional posts with detail on some of the terms and concepts introduced here – feel free to leave a comment below, we will respond in the comment section, or for more substantive items, in a new post.

 

 

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