Let’s start by clarifying the term “Investment Banking.” An Investment Bank is a financial institution that performs three core activities: Investment Banking, Sales and Trading, and Research. When we refer to Investment Bankers throughout this guide we are referring to the Investment Banking function (also called “corporate finance”) of the Investment Bank. Investment Bankers are essentially sophisticated business brokers: they identify opportunities in the marketplace that management may not be aware of, and facilitate a transaction. Typical transactions that investment bankers perform include:
- Minority Investments
- Leveraged finance (LBO)
- Asset financing and leasing
- Raising Capital (debt or equity) through public markets (also called a “primary issue”)
How an Investment Bank Raises Capital
- Investigation, Analysis and Research: All of these functions are to investigate whether the corporation and its securities are a sound investment decision for the public including a preliminary valuation of these securities.
- Underwriting: When a company wants to sell securities to the public, it enters into an agreement with the investment bank to sell the entire offering to the investment bank called an “underwriting.” The investment bank buys the securities from the company and then turns around and markets the securities to the public. The compensation to the underwriter is the spread between the price it buys and sells at, hence the analogy to a business broker. Often there is more than one underwriting investment bank (with one leading the charge as the lead underwriter) referred to as a “syndicate.” This reduces the risk to an investment bank associated with an offering, and also fosters goodwill among the banks.
- Marketing: Finally, after the investment bank or syndicate agrees to underwrite the securities, it goes out to market the securities to potential investors, also called a “road show.” This is where the investment banks magic comes into play. Because of its wide network of connections and marketing finesse, an investment bank can effectively market securities in a way that no company could.