An investment bank is a credit institution specializing in stock transactions.
Investment banks were first identified as a separate category of financial institutions in the United States in 1933. Then Congress passed the Glass-Steagall Act, according to which banks were prohibited from combining activities in the securities market with attracting and placing deposits. This was done in order to protect depositors’ funds from speculative investment operations during the Great Depression.
As a result, such major world leaders among investment banks as Morgan Stanley, Bank of America Merrill Lynch, Goldman, Sachs & Co., JP Morgan, Citi, Credit Suisse were created. After a change in legislation in 1999, their dominant position in the market remained.
According to the Investment banking by Rosenbaum and Pearl textbook, the main activities of investment banks include:
- assistance in the issue and sale of securities, underwriting;
- issuance of guarantees for the placement of securities;
- organization of intra- and off-balance sheet corporate financing (loans, promissory notes, bonds, shares);
- participation in reorganizations (mergers, acquisitions) of companies;
- organization of transactions related to syndicated loans and participation in such transactions;
- brokerage services for individual and institutional clients;
- dealer operations with securities;
- management of real and portfolio assets, funds.
Mergers and acquisitions
Small companies find it difficult to compete with large companies that have long occupied a niche in their industry. A successful start in business requires impressive capital and resources that not all entrepreneurs have. In such situations, mergers and acquisitions of companies can be an excellent solution. These are types of reorganization of commercial organizations, with the aim of uniting two or more economic entities and merging their capitals. Foreign sources refer to this concept as M&A – Mergers and Acquisitions. M&A deals provide opportunities to increase capital, resources and other important indicators of business performance.
The main goal of mergers and acquisitions is to increase profits. The main motive for most M&A deals is synergy. This is a mutually supportive collaboration of two or more companies, as a result of which the achievement of better results and higher profits is predicted.
The activities of an investment bank during mergers and acquisitions can be subdivided into the following components:
- consulting activities to determine the best option for business restructuring;
- attraction of financial resources for mergers and acquisitions;
- accumulation of large blocks of shares on the market at the request of a client (purchase of large blocks of shares), sale of large blocks of shares;
- restructuring of a separate company and sale of its parts;
- development and implementation of effective protection of the client from takeover.
Financial analytics and research
One of the areas of activity of investment banks is the provision of financial analytics on securities traded by the bank. By itself, these activities are usually not profitable. On the contrary, it has become one of the most expensive in investment banking. Thus, this type of activity can be classified as intermediate between the external and internal activities of the investment bank. To carry out external activities, the investment bank also develops internal activities that provide normal working conditions for those divisions that carry out external activities and make a profit.
What is a Leveraged Buyout (LBO)?
A funded buyout, or LBO, is the process of buying another company using borrowed money. The existing physical assets of the company are often cited as collateral. Sometimes such a sale of a business is forced and is called “hostile takeover”.
In a funded buyout process, companies prefer a private transaction over a purchase as a public entity.
LBOs in numbers
As for the percentage in calculating the loan issue, everything is quite simple. In most cases, it is a proportion of 70% and 30% to 90% and 10%: the first percent is the available capital of the buying company, and the second is the required amount of loan funds. This means that when buying a new business, the company invests 10% -30% of its funds and borrows the remaining 70-90% of the required amount. Quite a risky decision for an existing company: monthly loan repayment can cost a pretty penny for the business budget.
Such huge payments led to the bankruptcy of many firms in the 1980s in the United States. At that time, the practice of financed buyouts became so popular that banks offered cooperation on a 100% to 0% model. Thus, firms took full credit for the purchase of other businesses and in most cases could not cope with its payments. A similar situation is now observed in the sector of car sales to the end buyer: many of our fellow citizens use the opportunity to borrow a car without an initial deposit, but paying off the entire volume plus interest for many is an overwhelming task.
This principle for a funded buyout has also become popular with home mortgages. It is also the reason for the forced return of real estate to the bank to the borrower: many were unable to pay the monthly debt with interest for a long period of time and were forced to put up their homes for sale to pay the remainder of the mortgage.