WWhen you need to buy 1 kg of wheat flour, you go to your neighborhood grocery shop. But when you need to buy 1000 kg of wheat flour for your commercial bakery, you go to the biggest wheat flour wholesaler in the city!
Similarly, businesses with large, complex financial needs go to the country’s biggest banks. These banks are called investment banks.
Investment banks organize and enable large, complex financial transactions like mergers, IPOs, or underwriting.
Let’s take an in-depth look at what an investment bank is, and how businesses benefit from them.
What Do Investment Banks Do?
Investment Banks provide services to big businesses and corporations. They help in complex financial transactions like mergers and acquisitions, IPOs, and more.
In India, most investment banks are a part of a larger bank that also provides services to individuals and small businesses.
Let’s look at some of the services that investment banks provide:
Investment Banks Services
Initial Public Offering
When a privately-owned business wants to become a publicly traded company, it goes through an IPO, or Initial Public Offering.
Read more: Initial Public Offering
Investment Banks help businesses plan and strategize their IPO to ensure success. How do they do this?
Let’s understand with an example.
Meena wants to take her fashion business public. She wants to raise at least Rs 10 lakh in her IPO.
To do this, she approaches ABC Investment Bank. ABC then conducts intensive research and study into the market and informs Meena that the value of her business is Rs 2 per share.
This means that she would have to issue 5 lakh shares to the public.
Another way that investment banks help businesses go public is by underwriting.
Going public can be risky. If the public does not respond as well as expected, the business could be affected badly.
Investment banks help businesses negate some of this risk by buying up a portion of the shares and then reselling them to the public.
Let’s say ABC Investment Bank decides to underwrite 1 lakh shares out of the total 5 lakh shares that Meena’s business is offering. After consulting with various mutual funds and investment experts, ABC Investment Bank has decided to buy these shares at Rs 2 per share, which is now the value of each share.
Now that ABC has agreed to underwrite 1 lakh shares for Rs 2 per share, Meena’s business is guaranteed to raise a total of Rs 2 lakh!
In most cases, there will be more than one bank underwriting a business’s shares in this way, to reduce risk as much as possible.
Mergers and Acquisitions
Investment Banks also help businesses with big mergers and acquisitions of other businesses. There is a lot of complex financial planning to be done when two businesses are about to strike a deal.
Investment Banks help businesses with valuations, deal negotiations, and more.
Let’s continue with the example of Meena’s fashion business!
Now that Meena has taken her business live with ABC Investment Bank, she has been able to significantly upsize her company, and she is now sitting on a sizeable amount of cash.
She wants to put this cash to good use, so she decides to acquire Daniel’s footwear business which is doing very well.
Meena once again goes to ABC Investment Bank and tells them of her interest in acquiring Daniel’s business.
ABC Investment Bank will now analyze Daniel’s business, consult with industry experts and advise Meena on whether this would be a good deal for her or not.
ABC will also help Meena value Daniel’s business and come up with a purchase value – the amount that Meena will pay to buy Daniel’s business.
If Daniel wants a better price for his business, ABC will help Meena decide whether the higher price is worth it or not.
Once Daniel and Meena have agreed on a price, ABC Investment Bank will help Meena with the terms and conditions of the deal. It will also help Meena integrate the newly acquired business into her company in the most efficient way possible.
These functions seem very expensive, and they are! Investment Banking is a very profitable business, being one of the most highly paid careers in the world. But how do investment bankers make money?
How Do Investment Banks Make Money?
When an Investment Bank decides to underwrite an IPO, it usually sells the shares at a higher price.
In Meena’s example, ABC Investment Bank bought 1 lakh shares from Meena at Rs 2 per share. When ABC Bank sells those shares on the market, it might sell them at Rs 3.5 per share. This means ABC stands to make a profit of Rs 1.5 per share!
Investment Banks also charge a fee for services it provides, like valuing the business that is about to go public or in Mergers and Acquisitions.
There are a lot of other ways that investment banks make money, like Asset Management and proprietary trading.
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What do investment banks do?
Investment banks help business with complex financial transactions like IPOS and mergers & acquisitions.
What is the difference between a bank and an investment bank?
An investment bank specifically serves the complex needs of businesses and large corporations like IPOs and M&As. Regular retail banks serve the needs of individuals by providing savings accounts, FDs and RDs.
What do investment bankers do?
Investment Bankers work for investment banks. They have in-depth industry knowledge and are able to help businesses with valuations, investments and more.
Why are investment bankers paid so well?
Investment Banking is a very lucrative business. This is because without an Investment Bank, large business deals cannot go through. Investment banks charge a fee for their services and are able to pay their investment bankers high salaries.