Talking to many business school students, we feel that most don’t clearly understand what “Investment Banking” exactly is. Even professionals who haven’t worked in the industry have difficulties telling you what “Investment Banking” really is. Investment Banking has something to do with buying and selling stocks” – this is the greatest misconception out there. This post will give you an industry overview of Investment Banking and how the product groups differ from one another. We’ll also explain which group you should join depending on your situation.
Investment Banking includes five product groups. That’s Mergers & Acquisition (M&A), Equity Capital Markets (ECM), Debt Capital Markets (DCM), Leveraged Finance and Restructuring (aka Distressed M&A). These are the main product groups. Further, there are also industry groups. These groups specialize in a vertical and cover all product types, such as Healthcare. You will be doing ECM, DCM and M&A deals within the Healthcare sector vs. doing only M&A deals throughout multiple verticals.
Here is a quick overview of the main groups:
Mergers & Acquisition (M&A)
Equity Capital Markets (ECM)
Debt Capital Markets (DCM)
Leveraged Finance
Restructuring or Distressed M&A
Industry groups
Now, let’s walk through each of those groups and explain how they work.
Mergers & Acquisition (M&A)
M&A is probably the most known product group. Most will associate it with Investment Banking in general, which is correct. The M&A team is like a real estate agent for privately-owned companies. The house gets sold, the real estate agent receives a fee. The company gets sold, the M&A Investment Banker receives a fee. M&A is about helping companies to buy and sell privately held companies. It’s transaction-based business. It is not about buying, selling or trading stocks – that’s what Hedge Funds do. It’s about the entire company. In M&A, you will be dealing with Private Equity and Corporates. Those are the players who will swoop up a privately held company for EUR 50m to EUR 200m apiece.
Investment Bankers work on a commission base. They make most of their money when a transaction is completed. This is the reason why you are going to work extremely hard. Once sellers and buyers align, you must do everything you can to facilitate the transaction while having your Managing Director breathing down your neck. If the transaction falls through, you won’t get paid. On average, an Investment Banking Analyst will work around 60 to 80 per week most of the time.
Most consider M&A to be the most “prestigious” product group of the sell-side. The valuation part is the most analytical of all product groups. ECM/DCM valuations tend to be on the higher end of your comps range and that’s your price tag. On the other hand, in M&A, you have to get two parties to agree on a valuation of a company and convince them that the combination of the two entities will be lucrative in the long run.
We think M&A is the best product group to join because you get (1) the most transferable skills, (2) access to confidential information to see how companies operate, (3) M&A deals are constantly done and (4) it is difficult to be automated given the level of privacy and interpersonal skills required. If you are unsure, just starting out and want to keep your options open, M&A is your best bet. You get the most rigorous training that is not too niched down.
Equity Capital Markets (ECM)
“I want to work on IPO’s and raise equity funding.” This is exactly what you will be doing. You will spend most of your time advising companies on how to raise equity capital. You try to convince potential investors that they should pay X per share with your existing relationships. In other words, the company hands out a percentage of its shares in exchange for cash. ECM is more of a market-centric role.
Equity raises may include (1) Initial Public Offering, (2) Follow-On-Offering or (3) Registered Direct Offering.
On the valuation and financial modeling side, it’s a lot simpler compared to M&A or Leveraged Finance. You might value your target company via multiples of comparable companies or analyze the company’s ownership and capital structure after the offering. In other words, it’s your job to maximize the valuation of your target company. Your job is to tell a compelling story and get your client the highest valuation (aka the most money) for the shares they will bleed out.
ECM is more of a market-based role with a couple of trade-offs. The analytical work is less rigorous and more qualitative vs. M&A. In most cases, financial modeling is more on the light side. The work is more specialized, which limits your exit opportunities. On the flip side, the hours are better compared to M&A and compensation remains solid.
If you are unsure what to do and want to keep your options open, ECM might not be the best choice for you. If you are hyper-focused on Private Equity, ECM is not the ideal path. But if ECM is your best internship or job offer, accept it. ECM might work for you if you are in it for the long run and don’t want a quick exit. However, we advise you to pick a leader in fundraising. You need deal flow to make money and keep your job.
Debt Capital Markets (DCM)
Everyone can recall a famous IPO of a hot tech company. Nobody can name any billion dollar debt offering of an industrial company. Most people have no idea about things that are not “sexy” or headline-grabbing. DCM is similar to ECM in that you help a company to raise capital. However, the DCM team does not raise equity. The DCM team advises companies and governments on how to raise funds through debt securities.
Similar to ECM, DCM is a market-centric team. It’s their job to get your client, who wants to issue debt, favorable terms. To do so, you are pitching potential investors about debt issuances and taking care of their questions. Contrarily to ECM, it’s not about the growth potential of a company. DCM is all about security and avoiding losses because your upside is limited. You want to lend your money to the most secure bidder.
Here is a selection of debt securities: (1) long/short-term debt, (2) subordinated debt, (3) mezzanine debt, (4) convertible bonds and (5) bridge loans.
DCM is different from Leveraged Finance. DCM focuses on investment-grade debt issuances used for regular business purposes, such as investments into new machinery. Leveraged Finance focuses on acquisition financing for leveraged buyouts. This is more risky. If a Private Equity fund wants to acquire a company, it’s business for Leveraged Finance, not DCM.
In terms of valuation, debt comparables work differently than your traditional comparable company analysis. We are talking about offering date and amount, coupon rate, security type, current price, credit rating, yield to maturity, yield to worst, Debt/EBITDA, EBITDA/Interest and Free Cash Flow/Interest. This looks a lot different and very specific to debt compared to your typical EV/EBITDA multiple and EBITDA margin.
Looking at the two points above, DCM is not an ideal group for breaking into Private Equity either. Leveraged Finance takes care of acquisition financing, not DCM. Financial modeling is very specific to debt instruments and not rigorous enough for LBO modeling. DCM exit options are debt-related and go into corporate finance at normal companies, rating agencies or credit research. However, if you are into debt securities and credit-related roles, DCM might work for you. The same advice to ECM applies to DCM: pick a leader in fundraising. You need deal flow and business to keep your job and to get promoted.
Leveraged Finance
Leveraged Finance provides debt financing to Private Equity funds or corporations to buy other companies (aka leveraged buyouts). You will work with a lot with Private Equity funds. You will learn how these funds execute their transactions. It’s your job to check the creditworthiness of the potential buyout targets. After all, you are financing these transactions. Debt is used for acquisition financing to increase the return on equity. Debt is usually cheaper than equity. However, too much debt and the target company might be at risk of defaulting in case of an economic downturn.
Compared to ECM/DCM, you do more rigorous financial modeling. You are using debt to buy privately held companies that are less creditworthy. You have to build a full three-statement model with different business and financing scenarios. You are trying to understand whether the target company has enough earnings potential and liquidity to match the debt covenants. You are building models for actual leveraged buyouts and M&A deals. This is more rigorous than just picking the high end of your comps valuation and telling a compelling story. Part of your work will also include credit documents and amendments. The legal documentation may be tedious, but you need to fully understand the terms of debt issuance. You are working at the debt issuing bank after all.
Your hours will be a lot more in-line with M&A groups. You are working on the same flow of deals. The work is more complicated than a simple debt issuance. You have to understand the entire company to offer acquisition financing. Private Equity clients are very demanding and work long hours. The M&A adviser on the buy-side and sell-side also work long hours. So, you got to keep up with everyone else.
While this may all sound promising for your Private Equity exit, M&A still beats Leveraged Finance. Leveraged Finance only covers the acquisition financing part of the deal. While the credit side of a deal is important, it’s not the number one driver. The M&A banker covers all aspects of the deal, which makes you an easier sell for headhunters. But to be fair, Leveraged Finance is a solid group that will set you up for credit-related exit opportunities. You’ll have more options than in ECM/DCM and there are plenty of Leveraged Finance bankers who do break into Private Equity. You could also move to a different group at your bank or corporate finance roles at normal companies.
Restructuring or Distressed M&A
Restructuring or Distressed M&A is a niche sub-segment of Investment Banking. It is technically still Investment Banking but follows a completely different set of rules. This group gets called when everything is collapsing. When companies can’t pay their liabilities and are in distress, they turn to the bank's restructuring division to reorganize the company. We are talking about companies that are either weeks away from insolvency or are already under insolvency procedures. We are talking about debt restructuring (changing payment terms or schedule) to allow the company to restructure itself (divesture of non-core segments or optimizing operations). You need to have solid legal knowledge of debt agreements and insolvency procedures in your country for Distressed M&A.
Distressed M&A happens on a tight schedule. You are dealing with companies that don’t have a lot of cash left to survive. This is not the sunshine world where the shareholders consider cashing out at the peak of their journey. If a distressed business unit needs to be sold for the parent company to survive, it must happen quickly. As a result, your work hours will be long. Everything needs to happen as fast as possible. Your entire job is a fire drill. Companies come to your team when they are weeks away from insolvency. It’s like working in an emergency room.
This segment does exceptionally well during recessions. This is the time when structurally weak industries are getting in distress. The skillset you build is solid. Financial modeling is rigorous. There is more emphasis on credit agreements, cash flow and working capital. You have to dig into the business model to understand whether the business has a chance of success after insolvency procedures. However, a lot of the restructuring work does not happen in Excel or PowerPoint. It happens in long and tedious legal documents – aka the legal agreements of the real world.
There are usually fewer bidders in distressed sell-side processes – mainly competitors trying to consolidate market share. Prices are lower. Due diligence is much shorter – i.e., you know the company is already in distress. It’s more about minimizing the losses vs. maximizing the price. Additionally, you need to respect local insolvency procedures. You will be dealing with structurally weak verticals, for example, everything related to brick & mortar or travel & tourism. If that’s what you want, then it’s fine. But don’t expect to build expertise in cutting-edge technology. You will not make a VC exit out of restructuring.
Overall, it’s a good place to start. Just not as attractive as M&A. It’s a smaller and even more specialized sub-segment of Investment Banking. You are niching down very quickly because you are dealing with struggling verticals that are not attractive and specific legal knowledge about insolvency procedures. You will be quickly known as the “distressed” or “restructuring” guy. If you want to do restructuring to stay in restructuring, it may work for you. It is a less traveled path, after all.
Industry Groups
Industry groups focus on one vertical and cover different types of deals, such as M&A, ECM and DCM. This is different from the above-mentioned product groups that cover one type of deal in different verticals, such as M&A only. Industry groups go a lot deeper into a vertical as opposed to product groups. In product groups, you will start out as a generalist and specialize depending on your deal flow. Within an industry group, you focus exclusively on one vertical and build much more expertise within your vertical of choice.
Here is a selection of possible industry groups:
Technology, Media & Telecommunications (TMT)
Industrials
Consumer & Retail
Healthcare
Energy
Financial Institutions Group (FIG)
Real Estate Investment Banking
Given the pandemic, Tech and Healthcare are the two hot verticals right now (2021). Industrials, Consumer & Retail are more conventional and stable verticals. Energy is a more cyclical vertical. We would say that Industrials and Consumer & Retail are more plain vanilla verticals. There is nothing out of the ordinary with mechanical engineering companies or clothing brands with outlets vs. some obscure and revolutionary “app”. On the other hand, FIG and Real Estate are both entirely by themselves. FIG because they don’t offer services and products like a regular company. They make money with their balance sheets and receive interest income. Real Estate is Real Estate and has its own rules. You go into Real Estate; you stay in Real Estate. It’s a world by itself.
If you are committed to a vertical or want to break into Corporate Development, joining an Industry Group will give you an advantage. If you are a tech guy and laser-focused on Venture Capital, joining a TMT team might work out for you. The same applies to any vertical group. If you have a knack for that specific vertical and are personally interested in that vertical, you might as well match personal preference with your career path.
What’s not Investment Banking
This section should clarify any confusion about Investment Banking. Sales & Trading is not Investment Banking. Management Consulting, Lawyers and Big4 all say they do M&A or even have Private Equity practices. These groups do not do M&A as a bank does. They do not do deal execution, valuation nor do they identify potential investors. These groups support the transaction with commercial, financial and legal due diligence.
Sales & Trading is NOT Investment Banking...
Sales & Trading is not Investment Banking. Sales & Trading is Sales & Trading. It’s a division of its own. Yes, both Investment Banking and Sales & Trading facilitate transactions and get a commission for that. But that’s where the similarities end. In Sales & Trading, you help Hedge Funds and Asset Managers to trade stocks, bonds, FX, derivatives or commodities. This is where you trade with stocks and bonds. On the other hand, Investment Bankers help Corporates or Private Equity buy or sell privately held companies or raise debt/equity. Sales & Trading deals with securities and Investment Banking deals with the entire company – two completely different things.
Keep in mind that Sales & Trading is becoming increasingly automated and technology-driven. Your typical Sales Trader and Trader are becoming programmers. Many products are now traded electronically. Only the most complex and customized products require human interaction.
When Management Consultants say they do M&A…
Management Consultants don’t do M&A. They do commercial due diligence reports. They check whether the target company is commercially sound and whether the future growth potential is realistic. They may also develop a strategy that includes selling or buying companies and post-merger integration once you have acquired your target. However, the actual deal execution and valuation are done by Investment Bankers. Management Consultants work by a daily rate and not on a commission basis like all Investment Bankers.
When Big4 say they do M&A…
It’s usually the transaction services team doing financial due diligence. They check whether the accounts of historic financial statements match up with the presented figures. In particular, they check whether EBITDA adjustments are valid or not. This is called quality of earnings. This is important for the valuation basis before running your EBITDA multiple. A EUR 500k EBITDA adjustment makes for an Enterprise Value difference of EUR 5m with a 10x EBITDA multiple. However, Big4 companies also have their dedicated M&A deal teams. So yes, they do both financial due diligence and M&A. So, pay attention to the group you are applying for or joining. These are two adjacent but different lines of work.
When lawyers say they do M&A…
Lawyers take care of the legal documentation of an M&A transaction. They don’t find potential investors. They take care of non-disclosure agreements (NDAs), share purchase agreements (SPAs) and legal due diligence. But this line of work requires you to go to law school and pass the bar examination. So, nothing that your average finance student can even touch. The main point is lawyers don’t do M&A in terms of finding potential investors or raising funds. They take care of the proper legal documentation so that the transaction can be executed.
Where does it leave us?
If you are not sure where you want to go with your career, want to buy yourself some more time and keep your options open, then pick M&A. It offers rigorous training and the most versatile exit options. It is the hardest to automate and will always be around.
If you are laser-focused on Private Equity, pick M&A and Leveraged Finance. Stay away from ECM/DCM as the skill overlaps aren’t as good enough as in M&A or Leveraged Finance.
If you only have an ECM/DCM offer, by all means, go for it. You don’t have a choice and it is still a good place to start your career. It is still legit Investment Banking. There is no “bad” group. You will make good money.
If you are looking for a long-term career (+5 years) in Investment Banking, you have to get to a revenue-generating role. That means you have to choose the path where you will most likely get promoted, considering office politics and current demand. That’s where the real money is at. Nobody got rich being a Junior Banker. You may start out in M&A, but then you figure that you have a better path to Senior Banker in more specialized groups, such as Leveraged Finance or Leveraged Finance.
No one group trumps the other. Some groups may work better for you depending on your preference. The above is simply a quick overview of the different groups and how to think about them if you are undecided.
Additional resources
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