Investment banking is a sector within the financial services industry that is focused on the creation of capital. Investment banking clients are normally limited to businesses and governments. Investment banks offer a multitude of financial services to their clients, primarily limited to capital raising operations and mergers and acquisitions (M&A).
Capital raising services typically involve underwriting in capital markets. This essentially means that investment banks enable clients to issue stocks or bonds on their various markets. For example, if a privately-owned chain of grocery stores chose to issue publicly traded stock, they would approach an investment bank to issue an Initial Public Offering (IPO) on their behalf.
Mergers and Acquisitions services include advisory to companies that are considering a merger or acquisition, as well as underwriting debt to allow an acquisition to take place. Investment banks provide valuations that assist in determining the worth of a company for a party that is interested in acquiring it. M&A operations come with several risks, and it would be costly for a company interested in an M&A deal to identify and analyze these risks on their own. To avoid this, they hire investment banks to facilitate the deals.
Sales and Trading
In addition to these primary services, investment banks also provide services in sales and trading, research, and asset management. Put simply, sales and trading services help keep the ability for buyers and sellers to actually trade stocks stable and secure. One of these services is market making. When buyers and sellers in a market get together to trade, there might not be a lot of people who are buying or selling an asset at current prices. This can be bad for someone who wants to buy or wants to sell. Market makers are willing to buy and sell any security because they don’t actually hold onto these securities for the long-term. More often than not, when you place a trade, a market maker is the one who buys it at your bid price and then sells it at the seller’s ask price.
Here’s a simplified example of how they work. Imagine the bid and ask prices for a certain stock are $10 and $12 respectively for 100 shares of a company’s stock. Let’s now say that somewhere, an owner of that company’s shares decides to sell at whatever the highest bidder is offering, i.e. the bid price. A market maker will come in and offer to buy those shares at the bid price because that seller is willing to sell for the bid price. So, the market maker paid $1000 to buy the seller’s 100 shares. Now, the market maker offers those same shares to the buyer who was willing to buy at the seller’s ask price of $12. So, the market maker now sells those 100 shares to the buyer for $12 each for a total profit of $1200. The market maker has now netted $200. Imagine doing that for hundreds and thousands and tens of thousands shares each day, and one can see how market makers can make lots of money for every trade they help execute. The best way to think about the function of market makers is as movers of the inventory of stocks from the hands of sellers to buyers and making a little profit — the bid-ask spread — while doing so. This is the basis behind market making but there are some risks associated with market making that go beyond the scope of an introductory article.
The research services involve analysis and insights about companies, securities, economies, commodities, and really anything that has to do with markets. It used to be under the law that you didn’t have to have transparency in the research, so researchers could get inside information from talking to companies. That’s now illegal, and, now, research takes the information that they can get legally and tries to synthesize it and curate it so that people can understand it.
The asset management divisions of investment banks, often called their Wealth Management divisions, provide the same services as other asset managers. Both institutions and individuals need to be able to put their money to work. There are only so many loans that banks can make out with the money that people deposit with them, so investment banks created Wealth Management services to invest money in stocks, bonds, private equity, venture capital — anything other than just loaning out deposits to others. Investment banks asset management services seek to act as stewards or custodians to help investors earn returns. An important function of the investment bank’s asset management division is understanding each particular investor’s goal. These divisions, especially at the largest investment banks, manage hundreds of billions of dollars, so their actions on what to buy and sell can have a large impact on the market.
If one investment bank both creates investment opportunities and also buy into investment opportunities, one may wonder if there is potential for mismatch of incentives an investment bank to create and then buy into that investment opportunity and profit at the expense of other investors in that investment opportunity they create. As a result, there are many strict laws and regulations about having firewalls between different divisions so as to prevent corrupt behavior activities and promote proper actions.
Types of Investment Banks
Firms that are involved in investment banking are usually considered to belong to one of three categories. These are Bulge Bracket (BB), Middle Market (MM), and Boutique investment banks. Investment banks all differ in a number of ways, but the category they belong to is primarily determined by the scale of their operations as well as the typical size of deals they facilitate.
Bulge Bracket Investment Banks
Bulge bracket investment banks are the most well-known and recognizable of all investment banks. Examples of bulge bracket banks include, but are not limited to, J.P. Morgan, Goldman Sachs, Morgan Stanley, Merrill Lynch, and Barclays. Aside from the familiarity of their names, bulge bracket firms are set apart from other investment banks by the wide variety of services they offer and the value of their dealflow.
A major factor differentiating bulge bracket banks from other types is the scope of their operations. For starters, every bulge bracket bank operates on a global scale and has a presence in several economically significant countries.
While this article is focused on investment banking, it is important to note that bulge bracket firms are not only limited to investment banking operations. Bulge bracket banks each have three primary divisions: the Investment Banking Division (IBD), Sales and Trading (S&T), and Asset Management (AM). Within the investment banking division, bulge bracket firms offer services to their clients that include both capital raising and mergers and acquisitions services.
Bulge bracket investment banks typically facilitate deals with a value greater than $500 Million. It is common for bulge bracket firms to handle multi-billion dollar deals.
Middle-Market Investment Banks
Middle-market investment banks may not be as well known as bulge bracket firms but some prominent middle-market names may still be recognizable. Houlihan Lokey, William Blair, Baird, and Piper Sandler (formerly Piper Jaffray). Middle-market firms are commonly more restricted in operations than bulge bracket firms, but still offer a variety of services to their clients.
While the global reach of middle-market firms does not compare to that of bulge bracket banks, some middle-market firms may have offices overseas in prominent financial centers. They are also similar to bulge bracket firms in that they offer both capital raising and mergers and acquisitions services to their clients. The services that middle-market firms offer are comparable to that of bulge bracket firms.
The most notable difference between middle-market and bulge bracket investment banks however, is the value of the deals they facilitate. Middle-market firms typically only take on deals worth between $50 Million and $500 Million.
Boutique Investment Banks
There are a wide variety of boutique investment banks, and more prominent boutiques can be as well-known as their middle-market counterparts. Examples of boutique investment banks include Guggenheim Partners, Cantor Fitzgerald, and Evercore Partners. Boutique investment banks are set apart from bulge bracket and middle-market banks in that the range of services they provide is substantially limited. Some boutique firms limit themselves to mergers and acquisitions deals, for example, while others may be limited to capital raising. A boutique firm may only choose to facilitate deals within specific industries or a particular geographic region.
When discussing boutique investment banks, it is crucial to understand the difference between an Elite Boutique (EB) investment bank, and a Regional Boutique investment bank.
Elite boutiques are quite similar to bulge bracket banks in that they commonly handle large deals, often worth over $500 Million, and they likely have overseas operations. However, most Elite Boutiques offer a smaller range of services than bulge bracket banks, often only focusing on M&A deals. An example of an elite boutique investment bank is Moelis & Company. Moelis has several offices in the United States and nationwide and handles large deals, similar to a bulge bracket firm. However, they are limited to investment banking operations.
Regional boutiques, as the name implies, typically only operate in one particular region, and as a result, cater to a limited number of industries. This in turn limits the dollar value of their deals, which are small in comparison to bulge bracket firms. Because of this, regional boutiques normally do not have many employees and do not offer as many services as other banks do. They are often focused on only handling mergers and acquisitions. An investment bank that only has offices in the midwest and only handles deals related to the automotive sector would be considered a regional boutique.
Investment banking is a highly attractive sought after, though extremely competitive career. A career in investment banking comes with incredible future opportunities, promising career progression, and very high pay. There are very few entry-level jobs that offer similarly high salaries and prestige as investment banking.
This being said, an investment banking career comes with several drawbacks. An investment banking career requires excruciatingly long hours, often between 12 and 20 hours of work per day, weekends included. 80-100 hour work weeks are not uncommon. When you compare this to a standard 40 hour work week that is common of other careers, it becomes clear that investment banking comes with unparalleled requirements of commitment and levels of stress.
Additionally, investment banking is an extremely competitive career. Prominent investment banks usually only hire from top universities and business programs. If you do not attend a target university, it is still possible to break into investment banking but this requires significant networking and connections.
Most investment bankers were involved in some sort of a formal internship program prior to their career. Typically, investment bankers will have taken part in summer internships taking place after their junior and/or sophomore years of college. Internship experience makes an investment banking job candidate significantly more competitive in the application process.
Investment Banking Hierarchy
Within the investment banking division of an investment bank, bankers’ roles are organized in a strict hierarchy that is consistent across the vast majority of American banks. Investment bankers that are higher in the hierarchy will have higher salaries and greater responsibilities. While salaries are related to the position of the banker, they are not consistent across all investment bankers. Investment banking salaries involve bonuses that are dependent on the quality of work that a banker completes. Generally, bankers that are lower in the hierarchy will have roles related to financial modeling and organizing data, while those higher in the hierarchy will have roles related to client outreach and development. The hierarchy of investment banking positions, in order, is as follows:
- Investment Banking Analyst
- Investment Banking Associate
- Vice President
- Managing Director
Investment banking analysts are usually young, having recently graduated from a top university. Analysts that graduated from the highest ranked schools could come from a variety of academic backgrounds while those from lower ranked schools often have an academic focus in business, economics, or finance.
Analyst work is commonly described as “grunt work,” as analysts spend most of their time building financial models and work extensively with Microsoft Excel and PowerPoint. Analysts often get little sleep and are forced to work 80-100 hour work weeks throughout their time in that role. Investment bankers remain analysts for about 2-3 years before they are promoted.
It is important to note that many investment banking analysts do not have aspirations to work in investment banking for their whole career. After their 2-3 year analyst stint is over, a majority of bankers will choose to leave their firm and work in a different career, typically Private Equity, Corporate Finance, or Asset Management. It may seem confusing that someone would devote so much time to a job without the intention to pursue it further, but this is because of how valuable an investment banking analyst role is to a resume. Because of the nature of the work and the competitiveness of breaking into investment banking, 2-3 years as an investment banking analyst is comparable to 4-5 years working any other job. This results in a wide array of higher-paying and less grueling alternatives to investment banking for an analyst after their term is over. Many private equity firms, for example, will only hire applicants with analyst experience at a top investment bank.
Base salaries for investment banking analysts usually range between $70K and $100K, while total compensation (including bonuses) usually ranges between $130K and $200K. Salaries and bonuses increase with the years spent working as an analyst.
Investment banking associates have usually had 2-3 years of analyst experience, but can also include recent graduates from an MBA or graduate program (those with a graduate degree are typically not made to work as analysts) or those with past financial experience.
The role of investment banking associates changes dramatically throughout their time as an associate. In an associate’s first year, they will probably perform similar work as analysts and may be tasked with managing a group of analysts. As associates spend more time at an investment bank, the nature of their work becomes more focused on communication and management, and can act as a liaison between senior and junior bankers. Associates are responsible for ensuring the quality of the work performed by analysts. Bankers usually spend 4 years as an associate before being promoted to Vice President.
Base salaries for investment banking associates range between $140K and $180K while total compensation can be between $250K and $400K. Yearly bonuses for associates can be of equal or greater value than their base salary.
Vice presidents are the youngest of the “senior bankers” within an investment banking firm. VPs are not as accustomed to following orders as an associate might be and their role is much more related to the clients. Vice presidents have the task of completing pitch books, long documents marketing a particular investment banking transaction, as well as maintaining client relationships. As a result, the role requires much more social ability. An investment banker remains a vice president for an indefinite amount of time. Their promotion is highly dependent on the quality of their work and can be delayed significantly.
Base salaries for investment banking vice presidents are usually greater than $200K while bonuses are of similar value to the base salary. Salaries and bonuses for VPs are influenced by the performance of their work and the success of their proposals.
Directors and Managing Directors
As bankers become more senior, their work becomes less numbers-focused and they begin to take on roles relating to client management. This involves knowing everything about several deals taking place within the firm and ensuring that they are running smoothly. They are likely not actively involved in the operations of the deal. Their role is instead concerned with delegation. Job security is very low for a senior banker as if they fail to make the bank money, they can very easily be replaced.
Senior bankers earn a base salary of several hundred thousand dollars. With bonuses included, their compensation can reach into the millions.
Investment Banking Myths and Realities
Due to the complex nature of investment banking work, most people do not have a completely accurate understanding of the job. You may have heard statements about investment banking in the past that are mostly or completely untrue. Here are some common myths about investment banking careers.
Investment Banking Myths
- Investment Bankers Are All Rich
This is a myth largely perpetrated by the media’s description of an investment banker. While investment banking salaries are high when compared to other careers, there are significant differences between investment bankers and those in other careers that require that their money be handled differently. Firstly, investment bankers work very long hours and the work-life balance is minimal. This allows for little time and need to spend money on luxuries. The fact that there is little job security in investment banking means that a financially prudent investment banker will save a large portion of their total compensation, not allowing them to spend on luxury items. Additionally, as bankers become more senior, their compensation becomes much more dependent on the revenue of the bank itself. This means that in bad years, their compensation is substantially reduced.
- You Need Degrees In Math, Business, Or Economics To Become An Investment Banker
Many prominent investment banking firms hire applicants from a variety of educational backgrounds. This is especially true of applicants from top universities. Applicants with a background unrelated to financial services can also have greater industry knowledge. For example, those with degrees in STEM are highly coveted for investment banking roles because their degree allows them to understand the inner workings of scientific and technological companies.
- Investment Bankers Need To Be Good At Trading Stocks
This myth is very common and very untrue. Investment banking careers have no relationship to trading stocks (or bonds, commodities, or anything else). Being good at investing is a great life skill, but it will not apply in an investment banking career.
Though the public understanding of an investment banking career may be limited, there are probably several things about investment banking that are accurate.
Investment Banking Realities
- The Hours Are Long
As previously explained, the biggest disadvantage of a career in investment banking is the long hours. Schedules easily range from 80-100 hours weekly and junior investment bankers likely work weekends as well. As a result, balancing investment banking work and your personal life is difficult, but possible.
- Investment Bankers Go On To Have Very Successful Careers
Few careers provide opportunities as great as investment banking. Having an investment banking role on your resume will make you an attractive applicant for a variety of other jobs related to business and finance. It is not uncommon for investment bankers to go on to have executive roles at Fortune 500 companies or to have prominent roles in government.
A career in investment banking is lucrative and prestigious, but it is also extremely time and labor intensive. If you are interested in a career in investment banking, we highly urge you to do more research to ensure that it is the right fit for you. This being said, investment banks play a crucial role in our economy and becoming an investment banker comes with several opportunities that are hard to find elsewhere.
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