What is Investment Banking?
Investment Banking is a sector of the financial services industry that advises companies on mergers and acquisitions (M&A) deals and underwriting transactions (capital raising).
In simple terms, the core function of an investment bank – providing advisory services on M&A deals – is comparable to that of a real estate broker.
The investment banker connects buyers and sellers with aligned interests, negotiates the terms of the transaction, and structures the deal on behalf of the client.
On the subject of underwriting, a company in need of funds will hire an investment bank to find potential investors in the capital markets to provide the funds needed and manage the capital raising process.
- The investment banking function pertains to advisory services on mergers and acquisitions (M&A) and securities underwriting for corporate and institutional clients.
- The role of an investment bank is to act as an intermediary between clients and corporations (or institutional investors) to ensure proper guidance is delivered based on the firm’s expertise and past transactions.
- The skills required to work in investment banking are a combination of technical skills (e.g., financial modeling, valuation, market research) and soft skills (e.g., time management, effective communication).
- The top investment banks are divisions within large full-service banks referred to as “bulge brackets,” which include JPMorgan, Morgan Stanley, Goldman Sachs, and Citigroup.
- The “elite boutiques” are independent advisory firms that specialize in financial and strategic advisory services, with the most prestigious firms being Evercore, Moelis, Lazard, Centerview, PJT, and Qatalyst.
Table of Contents
- How Does Investment Banking Work?
- What is M&A Investment Banking?
- What Does an Investment Banker Do?
- What is Underwriting in Investment Banking?
- Product Groups vs. Industry Groups: What is the Difference?
- What is the Role of an Investment Bank?
- What is the Investment Banking Career Path?
- What are the Hours in Investment Banking?
- Why Investment Banking?
- What are the Investment Banking Exit Opportunities?
- What is the Investment Banking Analyst Salary?
- What is the Structure of an Investment Bank?
- Bulge Bracket vs. Elite Boutique: Which is Better?
- What are the Top Investment Banks in 2024?
- Front Office vs. Back Office: What is the Difference?
- Investment Banking vs. Commercial Banking: What is the Difference?
- Buy Side vs. Sell Side: What is the Difference?
- Investment Banking vs. Private Equity: What is the Difference?
How Does Investment Banking Work?
The role of an investment banker is two-fold, and both types of functions are a form of matchmaking:
- M&A Advisory: M&A is an umbrella term referring to the consolidation of two companies. When the investment bank advises a potential acquirer (“buy side” engagement), the firm helps identify potential sellers and later on negotiates the structure of the deal. Conversely, investment banks can also take the other side and advise the seller (“sell side” engagement). On behalf of the seller, the investment bank builds a list of potential buyers, markets the company, and manages the entire sale process.
- Underwriting (Capital Raising): Underwriting in investment banking comprises matching corporations in need of capital with institutional investors, such as mutual funds, hedge funds, pension funds, and sovereign wealth funds. The investment bank acts as an intermediary, managing the process and negotiating with institutional investors as part of the capital raise. Capital raises can take the form of equity issued by the company (e.g., initial public offering, or “IPO”) or debt issued by a corporation (e.g., bond issuance).
What is M&A Investment Banking?
In short, companies engage in M&A for the sake of growth, and there are two methods to achieve that outcome:
- Organic Growth: Companies can increase their revenue growth rate and profit margins through their internal initiatives, such as cost-cutting, to improve their operating efficiency.
- Inorganic Growth: In contrast, growth can be achieved by acquiring other companies to increase their collective market share and access to new end markets (i.e., customers).
M&A is thus an avenue for companies to accelerate growth beyond what can be accomplished organically.
From the perspective of the seller (or target company), the benefits of engaging in M&A are straightforward.
The shareholders can sell their entire equity stake and cash out in full, or the shareholders can opt to “take some chips off the table” and participate in the potential upside of the newly formed entity.
What Does an Investment Banker Do?
The core function of an investment banker in M&A is to provide financial and strategic advisory services to guide corporate clients through the complexities of M&A deals.
- Buy-Side M&A: On a “buy-side mandate”, investment bankers serve as advisors to the acquirer (i.e. the buyer) and must determine if the client’s proposed transaction is reasonable. The priority is to ensure the offer price is justified to reduce the risk of overpaying for the underlying asset (e.g., an entire company or individual business segment).
- Sell-Side M&A: In contrast, investment bankers on a “sell-side mandate” are hired by the seller to advise on the deal and ensure the offer price is fair, without “money left on the table.” For example, when Microsoft acquired LinkedIn, Morgan Stanley advised Microsoft, while Qatalyst advised LinkedIn.
Generally, the volume of M&A activity – the number of deals by count – tends to rise substantially amid periods of economic expansion, which reverses amid periods of economic contraction.
The performance of the IB industry is sensitive to the macroeconomic environment and the current state of the capital markets.
If the economy and credit markets are strong, the volume of M&A transactions tends to increase, resulting in more revenue for investment banks via the collection of fees.
Conversely, if financial markets and economic conditions are poor, investment banks experience much lower activity (and thus lower deal fees).
Besides advising on traditional mergers and acquisitions (M&A) deals, two other types of transactions fall under the broader umbrella of M&A advisory services offered by an investment bank:
- Corporate Restructuring: The corporate client is at risk of insolvency and must urgently figure out a plan to return to a state of normalcy (i.e., operate as a “going concern”).
- Divestitures: The corporate client requires guidance on a partial or outright sale of a business segment or division (e.g., spin-off).
Investment banks offer restructuring advisory services for struggling companies that are considering options like bankruptcy, distressed sales, and defaulting on their debt.
Historically, the demand for restructuring advisory services tends to pick up when the economy is weak, offsetting weaknesses across other parts of the IBD for banks that have this very specialized expertise.
Sometimes businesses decide to get rid of a certain business segment, most often after a period of underperformance – perhaps, the segment no longer fits within the overall strategy of the firm, the company requires capital (post-sale proceeds), or the segment is worth operating as a standalone entity.
eBay and Skype Divestiture | Real-Life M&A Example
For example, in 2009, eBay decided to sell its majority stake in Skype at a steep loss to a group of private investors that included Silver Lake, the Canada Pension Plan (CPP), Index Ventures, and Andreessen Horowitz (a16z).
eBay acquired the fast-growing VoIP communications platform Skype in 2005 for $2.6 billion to integrate the innovative technology into its e-commerce auction site.
However, eBay soon after acknowledged that the integration of Skype was a failure because buyers and sellers on the site were uninterested in building relationships or even communicating on a personal level.
The privacy aspect and post-acquisition cultural issues contributed to eBay’s decision to “cut their losses” by divesting Skype for $1.9 billion in cash while retaining approximately 30% of their initial investment.
The divestiture valued Skype at $2.75 billion, exceeding the original purchase price paid by eBay in 2005.
eBay hired Merrill Lynch as the investment bank advising on the acquisition of Skype back in 2005 and then later hired Goldman Sachs to advise on the divestiture in 2009.
The partial divestiture, where eBay retained a 30% stake to participate in the potential upside of Skype, proved to be a profitable decision after Microsoft’s buyout of Skype in 2011 for $8.5 billion.
The outcome? eBay obtained a net gain of $1.4 billion from the transaction.
What is Underwriting in Investment Banking?
The other core function of investment banking is securities underwriting, which describes the advisory services related to helping clients with their capital raising needs.
If an investment bank wins an underwriting mandate – where the firm is hired by a client to help it raise capital – the investment bankers facilitate the financing in the form of either debt or equity.
- Debt Underwriting: The client obtains the necessary funding by issuing loans and bonds (or other forms of debt securities) to investors. Bonds come in a variety of shapes and sizes, but the basic idea is that the company obtains capital from investors on the present date in exchange for agreeing to meet periodic interest payments and return the original principal at maturity. Once the company raises the necessary capital, the investment bank collects its fees, and investors can either hold the bonds or trade them in the open markets.
- Equity Underwriting: The client obtains the required funding by issuing new shares to investors. The shares represent partial ownership stakes in the equity of the issuer. Once a company undergoes an initial public offering (IPO), the company raises a significant amount of capital, the investment bank collects its fee, and the shares of the issuer are listed on a public exchange like the NYSE, and now start to trade freely in the stock market. Once a company goes public (post-IPO), the issuer can continue to raise capital via follow-on equity offerings, although the occurrence is less common. Equity issuances after the IPO are formally termed “secondary offerings” and must be approved by the SEC.
Similar to the pattern in M&A activity, an economic slowdown or expected recession usually causes the capital markets to “dry up,” which is reflected by the reduction in IPOs because of insufficient interest from institutional investors.
A dim economic outlook among investors and corporations results in a more conservative approach to raising capital and participating in M&A across all sectors, albeit there are certain firms like distressed funds that strive to capitalize on (and profit) from mispriced securities in the capital markets.
Product Groups vs. Industry Groups: What is the Difference?
Most investment banks organize their teams into product groups and industry (aka “coverage”) groups:
- Product Groups: Product groups specialize in a particular product offered to clients, such as a specific deal type (e.g., M&A advisory, restructuring, leveraged finance). Usually, a product group is industry-agnostic, meaning that the services are offered across all industries.
- Industry Groups: Industry groups, or “coverage groups”, are specialists in a particular industry, like healthcare, tech (TMT), industrials, and energy. Industry coverage groups normally “quarterback” client relationships, often resorting to the relevant product group on a need-basis once the necessity for deeper expertise within a subject matter arises.
What is the Role of an Investment Bank?
To advise on a deal, an investment bank must convince the client to hire them based on their past transactions, credentials, and industry expertise, among other factors.
Senior investment bankers, particularly coverage bankers, are responsible for maintaining relationships, pitching ideas, and staying in the mix to win new business – which are tasks collectively referred to as deal origination (or “sourcing”).
Meanwhile, the junior bankers complete a wide range of tasks to support the team of senior bankers, which include but are not limited to creating pitch books, performing preliminary diligence, managing conference calls (i.e., scheduling meetings via email), and organizing client material.
Once an investment bank wins a client mandate, deal execution work begins thereafter.
The senior bankers lay out the strategy, manage the negotiations, and step in at critical points to keep the deal from veering off course.
The junior bankers provide all the support to ensure the deal process remains on track, with the most common tasks being the following:
- Conduct Financial Analysis (e.g., Profitability and Credit Risk Analysis)
- Perform Financial Modeling in Excel
- Build Valuation Models (e.g., DCF Analysis, Trading Comps, and Transaction Comps)
- Create Pitchbooks and Marketing Materials
- Conduct Due Diligence to Perform Client-Specific Research
What is the Investment Banking Career Path?
The traditional career path in investment banking and the structural hierarchy have remained rigid.
The seniority structure from most junior to most senior can deviate by firm, but the differences (and the pace of promotions) are marginal, for the most part.
- Investment Banking Analyst: The analyst is the entry-level position in the industry and, therefore, must handle the most mundane tasks, such as performing company research, analyzing financial statements (i.e., deal room), creating financial models, and preparing presentation material.
- Investment Banking Associate: The responsibilities of an associate are relatively similar to an analyst, aside from marginally reduced hours and the added task of reviewing an analyst’s work. While the associate is more actively involved in discussions about deal engagements and pitches, the role is not client-facing.
- Investment Banking Vice President (VP): The vice president (VP) manages the firm’s teams of analysts and associates to oversee the workflow and ensure the material’s quality meets the managing director’s standards (and ensure all deadlines are met).
- Investment Banking Managing Director (MD): The managing directors (MDs) are the foundation of the firm’s deal origination process, as their responsibilities include managing the pitch to the client and ensuring the closure of deals. The deal flow of an investment bank is a byproduct of the existing connections of its senior bankers with corporate executives and institutional investors (and their ability to build their networks).
What are the Hours in Investment Banking?
The investment banking industry is notorious for its long hours and challenging workload.
At its worst, junior investment banking analysts can expect to face work weeks of 80 to 100 hours.
In recent times, investment banks have attempted to reduce the workload with “protected weekends” and other measures. However, the culture of long hours is deeply rooted in investment banking.
At many firms, old habits die hard, particularly in “live” deals, which often means junior bankers are “on call” at all times.
Unfortunately, the long hours are often also notoriously caused by idle time spent awaiting deliverables from a client or their advisors; that trait has historically been and will continue to be a routine part of the business model.
The investment banking profession is a challenging role that requires working long hours with a high-stress tolerance, yet the career path is certainly rewarding in terms of the “upside” potential in compensation over the long run and attractive exit opportunities.
Why Investment Banking?
Given the hours and demanding workload, why do so many top university students continue to pursue investment banking post-graduation?
One of the most cited reasons is the doors that open from working at a prestigious investment bank.
Most junior analysts work a one-to-two-year stint in investment banking as a “stepping stone” to a different, often more prestigious, career path.
There is also the wide range of skills gained on the job to consider, where analysts “drink from a firehose” in investment banking.
Soon after joining the firm, analysts learn financial modeling in Excel, create client presentation material, perform industry analysis, and grasp the “ins and outs” of different business models.
The skills gained are also broadly transferrable across a variety of future endeavors as analysts quickly learn to become reliable, detail-oriented, and work efficiently in high-pressure situations.
What are the Investment Banking Exit Opportunities?
The most common exit opportunities for investment banking analysts are outlined in the following table:
|Private Equity (LBO)
|Hedge Fund (HF)
|Venture Capital (VC)
|Growth Equity (GE)
|Real Estate Private Equity (REPE)
Note: Other exit opportunities available to investment bankers, other than on the buy-side, include roles in corporate development, startups, entrepreneurship, FP&A, and more.
What is the Investment Banking Analyst Salary?
Briefly, the compensation structure in the investment banking industry is two-fold:
- Base Salary → The base salary component is the fixed portion of the analyst’s salary guaranteed to be received, assuming the analyst is not laid off by the firm.
- Bonuses → The bonus component, however, is variable and contingent on various factors, namely individual performance.
The bonuses issued by investment banks can easily exceed the base salary of their analysts.
The performance of the firm and group, aside from the individual performance review, is also a critical determinant in the size of bonuses (i.e., the “top-bucket” analysts receive the highest bonuses).
The average salary for investment banking analysts – updated to reflect industry-wide 2024 compensation trends – is described in the following table:
|All-In Comp (Base + Bonus)
The ranges reflect the “standard” base salary and bonuses received by investment banking analysts.
The state of the M&A market and the firm’s performance can cause the “all-in comp” to fluctuate substantially, a function of the economic conditions and current state of the credit markets.
What is the Structure of an Investment Bank?
While the core functions of investment banks are relatively similar for the most part – i.e., M&A advisory and capital markets advisory services – the organizational structure and divisions of the bank itself can differ substantially based on its categorization.
Before getting into the structure of investment banks, let’s first distinguish between a full-service “bulge bracket” investment bank and a “pure play” advisory boutique.
Full-service investment banks that provide a comprehensive suite of offerings to their clientele, including:
- Investment Banking (IBD)
- Sales and Trading (S&T)
- Equity Research
- Asset Management
- Commercial Banking
- Corporate Banking
Still, insiders often refer to full-service banks, like JPMorgan and Morgan Stanley, broadly as “investment banks”, despite the fact that those firms have other divisions such as commercial banking, corporate banking and asset management.
Note, the “Sales and Trading” division is not considered to be part of the investment banking function.
- Sales and Trading (S&T): The S&T division within a financial institution makes a market in stocks, bonds and derivatives and fills orders on behalf of institutional investors. While the sales and trading teams often are involved in supporting the investment banking division by reaching out to investors to support an IPO or debt issuance, “investment banking” refers to the advisory and underwriting part of the work.
- Equity Research (ER): The ER division supports the sales and trading division with research on specific public equities based on their industry coverage. Like sales and trading, equity research is also not considered “investment banking”.
Organizational Structure of Full-Service Investment Bank – Illustrative Example
Bulge Bracket vs. Elite Boutique: Which is Better?
Contrary to full-service investment banks, or bulge brackets, elite boutiques are independent advisors that specialize in a particular product group or industry.
From a client perspective, the biggest practical difference between bulge bracket investment banks (BBs) and elite boutique investment banks (EBs) is that full-service bulge brackets “have a balance sheet”.
Having a balance sheet means the bank advising a client has direct access to capital. That means, for example, that the bank can serve as both an advisor on an M&A deal as well as provide the financing for the acquirer to fund the deal (if needed).
The pure-play boutiques can only provide advisory services, although certain EBs have started to diversify their revenue sources, such as Evercore’s acquisition of ISI Group.
You might immediately assume this means bulge brackets have a significant edge over boutiques. But it is a little trickier than one might think.
While the bulge brackets will certainly tout this advantage, the boutiques can counter by arguing that this is, in fact, a disadvantage.
That is because bulge brackets might be incentivized to push their firm’s financing solutions to the detriment of finding the best option for their clients (i.e., conflict of interest).
Boutiques, having no such conflict, can thus help the client secure the “cheapest” financing by helping the client solicit a broad range of potential financing options.
What are the Top Investment Banks in 2024?
The following table lists the top bulge brackets and elite boutiques at the forefront of the investment banking industry, considered the most prestigious firms at the start of 2024.
|Bulge Brackets (BBs)
|Elite Boutiques (EB)
There are also up-and-coming firms such as LionTree (TMT) and FT Partners (FinTech) held in high esteem in their respective niches, as well as prestigious firms such as Allen & Co. and M. Klein & Co. that intentionally maintain a low profile.
Front Office vs. Back Office: What is the Difference?
Thus far, we’ve discussed the core functions of an investment bank and the role of an investment banker.
However, the distinction between various roles within the bank must also be understood.
In most cases, an investment bank is separated into three sections:
- Front Office: The front office is the client-facing segment of the investment bank that generates revenue, such as the M&A advisory, capital markets, and sales and trading (S&T) divisions.
- Middle Office: The middle office is intended to support the front office, particularly in risk management and ensuring the firm complies with regulations.
- Back Office: The back office refers to roles that support firm-wide operations, such as the human resources (HR) department, accounting staff, and information technology (IT).
The prestige of a career in investment banking is namely focused on front-office roles. However, the contribution of middle office and back office roles is an integral part of the business model.
Investment Banking vs. Commercial Banking: What is the Difference?
The investment banking and commercial banking functions provide entirely different services and serve different clients, contrary to a common misconception.
- Investment Banking: Investment banks offer advisory services that pertain to mergers and acquisitions (M&A) and securities underwriting. For example, the firm could raise capital in the form of debt or equity financing on behalf of a client in need of funding. The clients served by investment banks are normally institutional investors, such as private equity firms and corporations.
- Commercial Banking: Commercial banks offer services related to managing deposit accounts, such as checking and savings accounts, besides underwriting smaller-sized loans (i.e., lending) and processing transactions. The clients that commercial banks serve are small to mid-sized businesses (SMBs) and large enterprises.
Buy Side vs. Sell Side: What is the Difference?
The term “sell side” refers to investment banking, while the “buy side” is an all-encompassing term composed of institutional investors, from private equity firms, hedge funds, mutual funds, insurance companies, and pension funds to university endowments.
The differences between a career on the sell-side and the buy-side are as follows:
- Sell-Side: Investment banks, or the “sell side,” attempt to provide their clients with sound advice given their situation, such as considering a tender offer or strategic acquisition. The revenue model in investment banking is structured around the collection of fees for providing advisory services to clients.
- Buy-Side: In contrast, the “buy side” prioritizes generating profitable returns on behalf of their limited partners (LPs). For instance, the LPs of a private equity firm contribute capital to the fund, which the general partners (GPs) intend to deploy into profitable investments to exceed the minimum target return set in the initial stages of raising capital. The private equity industry specializes in leveraged buyouts (LBOs) and realizes a profit from the investment post-exit, which could be a sale to a strategic buyer, a secondary buyout (SBO), or an initial public offering (IPO). Over the holding period, the private equity firm earns an annual management fee to cover overhead costs, followed by an agreed-upon split on the profits earned from the fund’s investments (i.e., the traditional “2 and 20” fee structure).
Investment Banking vs. Private Equity: What is the Difference?
To further elaborate on the prior section, the private equity industry (PE) is the most sought-after exit for investment bankers, after working on the sell side for one or two years.
In fact, the interest in securing a buy-side role among junior investment bankers (and the competition among private equity firms to recruit the top talent) in 2023 was competitive to where the recruiting cycle kicked off in mid-July before the analyst class could be staffed on a live deal or complete new hire training.
- Investment Banking: The rationale for investment bankers to exit to the buy-side, aside from higher compensation, is most often tied to the type of work performed daily, i.e., advisory services vs. an investment role. As a newly hired investment banking analyst, a substantial proportion of the work is related to following instructions and performing menial tasks, like editing client marketing deliverables, while the tasks completed by investment professionals on the buy side tend to be more intellectually engaging – a factor that many perceive as necessary to a long-term career.
- Private Equity: The hours and workload on the buy side are normally more manageable with an improved work-life balance (and compensation). Yet, the statement that working on the buy-side is “easier” per se is a misinformed notion. The hours and workload on the buy-side are comparable to investment banking (i.e., there is only a marginal improvement relative to the sell-side), especially right after exiting investment banking into an associate role at a private equity firm.