8 Interesting Facts About the Investment Banking Business Model
Investment banking is a business that is at the core of the financial industry. However, investment banks have a different business model than many other businesses in the industry.
Investment banking focuses on offering financial advice to companies about their investment needs. It is one of the most financially rewarding businesses because of the many ways in which they make money.
The following are eight interesting facts about the investment banking business model:
1. Investment Banks have Several Divisions
Most people think an investment has one main division which is the one responsible for helping companies raise capital. The fact is that there are several divisions or offices in an investment bank all of which are crucial to the operation of the company.
The front office of the investment bank is responsible for making the revenue and hence is often mistaken for the only one. They earn commissions based on underwriting share subscriptions for companies.
The middle office is responsible for quality control which means they ensure that the front office doesn’t take on too much risk. The back office is responsible for doing the hard technical analysis and compiling financial reports for the bank’s clients.
2. They Buy Shares Then Sell Them
A common misconception about underwriting the issue of share capital by a company is that the public buys them from the company. It is quite a wrong tale which can lead to many problems.
The business model of an investment bank involves buying shares directly from the company and then selling them at a slight premium. That is how they make money from IPOs and new stock issues.
They will typically buy all the shares that the company is willing to sell to the public. Therefore, if there is not enough demand for the shares, the investment bank and not the issuing company will hold the remainder of the company stock.
3. Selling Shares is Not the Main Business
Despite being one of the main functions of an investment bank, selling shares to the public is not where investment banks generate most of their business. The vast majority of business done by investment banks includes mergers & acquisitions, corporate restructuring, and leveraged finance.
Working with companies to raise capital for various purposes is a crucial part of any investment bank’s operations. It does earn them significant revenue but working with other companies instead of the public yields the most revenue.
Therefore, if you are an investment banker, you should not expect to always be dealing with the public. Instead, you will be involved in highly technical corporate procedures for the most part.
4. Pitching Deals is Crucial
Most people studying to become an investment banker think that there is a lot of technical analysis to be done on the job. Though financial analysis is essential to the operations of an investment bank, pitching deals to prospective clients is just as important.
Therefore, sales skills are extremely important to an investment banker. When learning how to become an investment banker, you should look at how to improve your sales skills. They will definitely come in handy in the future.
You will receive some on the job training when you become an investment banker and most of it will do with pitching deals and creating relationships with potential clients. However, you should work on your sales skills as much as possible before that.
5. The Bank Does the Marketing
When selling shares to the public, a lot of interest needs to be generated so as to ensure full subscription. The investment bank will do most of the marketing and will include a substantial part of their business.
Seeing as how most business is conducted online these days, digital marketing will be a crucial factor in the sale of company stock. They will conduct both online and offline marketing operations to ensure that enough of the shares are sold.
Therefore, a substantial advertising budget is a crucial component of every investment bank’s working capital. Marketing is a seminal part of the investment banking business model.
6. Analyst Reports Matter
When you become an investment banker, chances are that you will work in the back office as an analyst unless you have an advanced higher education degree. An interesting fact about the business model of investment banks is the importance of analyst reports.
The reports generated by analysts involved evaluating various aspects of the business particularly the financials. These reports can provide a lot of insight into the state and performance of a business.
It is based on these reports that the front office of the investment bank will act. Therefore, these reports on equities, debt, and corporate structure are essential to the business model of an investment bank.
7. They Trade of Their Own Account
An investment bank primarily underwrites the issue of new shares by a company. They will purchase these shares at the price the company sells them and in turn sell them to the public for a profit.
However, they can also sell the older stock of other companies from their own account. It accounts for a significant fraction of many investment bank’s revenue.
Therefore, a substantial part of an investment bank’s operations involves taking on risk by trading shares. On the other hand, it is usually a very profitable venture that pays investment banks handsomely.
8. Focus on Particular Industries
An investment bank has the authority and leeway to underwrite the shares of any company. However, according to the business models of most investment banks, they tend to focus on particular industries.
As stated above, a lot of an investment bank’s work will involve corporate restructuring, mergers & acquisitions, and leveraged finance. The more versed a bank is in the operations of a particular industry, the more adept it will be at performing the above functions.
Therefore, an interesting fact about investment banks is that they will focus on an industry such as financial services, engineering, technology, real estate, and natural industries.
To conclude, the business models of investment banks are quite different. However, there are often large similarities among them. The above are some facts about investment banks’ business models. There are many more which you should find out if you want to become an investment banker.