Imagine that you work in a corporation, or you are going to launch your startup. Financial transactions are bound to be very complex and broad in these institutions. Amidst all these, can a regular commercial bank settle things out? Certainly not. You need an investment bank to do that for the corp.
The study gradually elaborates on the definition and types of investment banks. It will discuss the functions in the latter part.
Investment Bank Explained
An investment bank is a financial service-providing institution that aims to act as an intermediary in large and complex financial endeavors.
In simple words, an investment bank works as a middle man for other large companies and financial institutions, managing their financial transactions. Large corporations, startups, and other financial institutions often require financial assistance.
For a regular bank, it is tough to meet up the financial needs of such extend. However, investment banks are usually involved when you want to launch a huge startup, or two corporations are aiming to merge up, or any financial institutions require to conduct a financial transaction.
For startup companies, an investment bank can generate an initial public offering or IPO. On the other hand, they can also work as a broker or financial advisor for various corporations and financial institutions.
Investment Banks limits the risks of their clients by working as financial advisor. Normally, when a corporation tends to deal with a financial entanglement, it often becomes biased before the company’s interest.
Investment banks take unbiased decisions that will be beneficial for the corporation itself. Not to forget, they take the risks to conduct a potential merger of two corporal bodies for the sake of financial welfare. In sort, investment banks take the risks, execute fool-proof financial decisions, and succeed, mostly.
Types of Investment Banks
Investment banks generally offer two services. One is underwriting debt financing and the other is issuing equity securities. We will be looking into these services in a broad spectrum later in our discussion. As of now, we will be focusing on the types of Investment Banks.
You see, Investment Banks can be Categorized into Three Major Types. These are:
- Bulge Bracket Banks
- Middle-Market Banks
- Boutique Banks
Boutique Banks can also be divided into two sub-types. These are:
- Regional Boutique Banks
- Elite Boutique Banks
The types of investment banks are determined according to the operations and the clients. Many of you might relate these types according to the number of employees, size of deals, and significance of clients. You are not wrong though. Anyways, you will clear all your doubts out in the following segments.
Bulge Bracket Banks
If your company is listed in the Fortune 500 or Fortune 100, your company deals in multibillion-dollar deals regularly, then Bulge Bracket Banks are your trusted handlers.
As you have guessed, Bulge Bracket Banks are the largest of all investment banks. Goldman Sachs, Deutsche Bank, Credit Suisse Group, Morgan Stanley, Bank of America are some of the most recognized Bulge Brackets in the business.
The majority of the clients are Fortune 500 companies or Fortune 100 companies. These companies require large handling in deals and multibillion-dollar contacts. To meet up the needs, Bulge bracket banks requires the largest number of employees and financial professionals to address the need of their clients.
Each of the banks operates both internationally and regionally. The major investment services include trading, financing, asset management, equity research and issuance, and so on.
Middle-Market Banks
This type of investment bank represents the exact meaning of the name. Middle-Market Banks work as middlemen between smaller regional investment banks and the might bulge bucket banks.
It might be not as big as the bulge bucket, but it fills the void between the two ends. Middle-market banks usually work on deals that are conducted at the regional level. The range of the deals can be between 50 million US dollars and can crank up to 500 or more.
The geographical reach of these banks has become the differentiating factor. As the bulge bucket banks can operate both on and off the shore, middle-market banks can only operate within the landscape. They hold a pretty strong grip on the regional market.
The bright side is that it is capable of offering the same full range of services as the bulge bracket banks. Services like equity capital market and debt capital market services, financial and asset management services, M&A, and conducting deals are the main services of the Middle-market banks.
Regional Boutique Banks
This is perhaps the smallest of the investment banks. It is the smallest in size as well as capacity. Small firms, startups requiring IPOs seek financial assistance from these banks.
As these banks are small, they can be limited to a single province or a city. The usually targets one sector of the market of the specific geographical area. Then choose clients and companies that are running their business in the same market spectrum.
Usually, they offer a limited amount of services. They mainly manage and handle M&A deals for various small companies and startups.
Elite Boutique Banks
Elite Boutique banks are nothing but upscaling the regional boutique banks. Regional boutique banks tend to do business and grow over time and expand. Resulting in creating several offices. They often end up closing larger deals for prestigious clients. Thus, they become part of the elite group.
Elite boutique banks are often considered as large as bulge bucket banks for a set of reasons. They can operate both on and off the shores like the bulge buckets. On top of that, they can pull off a deal that can be as big as a billion-dollar mark.
However, the services and the limitations do make this bank a boutique in nature. They still do M&A-related deals and management for their prestigious clients. On the brighter side, many elite clients and companies prefer elite boutiques for their financials for their simplicity and flexibility.
Functions of Investment Banks
Investment banks do not offer a wide range of functions like commercial banks or retail banks. However, here is the top 3 functions that investment banks offer to their clients.
IPO (Initial Public Offerings)
Imagine you own a chain of food trucks in Nevada. Now, as you want to expand your business all over the US, you need funding.
Investment banks offer you that funding by issuing IPOs. When you go to an investment bank, they evaluate your company. Upon the valuation, you might decide what percentage of your total valuation you are agreeing to give up for the investment.
Let’s say that you have a valuation of 100 million and you are willing to give up 10% of your company. The investment bank will then issue shares of that 10% and sell those to potential investors via stock exchanges.
The shareholders will have fair equity in your company and the investment you will receive is known as IPOs.
The bank here acts as a broker. In many cases, it also underwrites the shares to generate enough IPOs to conduct business.
Merger and Acquisitions
This is the process of joining two ventures to strengthen the financial infrastructure. Investment banks often play as the merger middle man between two companies that requires a merger.
The bank either works from a view of seller representation or a buyer representation. However, the main role of this service is evaluating the company.
The bank is responsible for the valuation of the company. Upon the valuation, the bank builds its strategy for M&A. In major cases, the bank also arranges funding for M&A-related proceedings.
Risk Management
Risk management is perhaps the most vital service of investment banks. Imagine that you are a company. You might take many financial decisions and conduct many deals that might suit your interest.
However, the decisions that you take might not be that beneficial.
Not only that, but they also ensure and spread out counterparties, manage the standard exchange of trading to limit credit risks as well.
Many businesses require additional help in managing business risks, investment risks, and other calamities. Investment banks work as financial advisors to guide the company smoothly through the rough tide.
How Investment Banks Generate Income?
Unlike commercial banks, investment banks do not charge or play with interest rates. They work as a middle man or a broker. Upon every successful deal, they charge their brokerage.
Making money in investment banking is not that easy. However, investment banks evaluate the market and your business before investing in it. So, they limit the risk beforehand.
Investment Banks vs. Commercial Banks
Investment banks typically underwrite new debt and equity securities for their clients. Whereas, commercial banks provide loans to their clients as well as offer various other deposit and saving services.
Commercial banks’ target market is individuals and small firms. Investment banks do not deal with individuals. They deal with companies, startups, and other financial corporations and institutions. Commercial banks earn from interests and service charges and investment banks earn from brokerages.
Bottom Line
Investment banks, despite being the bridge between investors and business are vulnerable in many cases. The spikes have faced ups and downs throughout history. So, it is highly likely that the bubble will pop once again.
Public funding and kick starters can be a worthy alternative for investment banks shortly. However, as of now, investment banks are the key banking process for our economic stability.
Related Reading