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Functions of the Investment Banker

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Three primary functions constitute the role of an investment banker: developing new business, structuring transactions, and making client presentations. A new associate usually spends the first year of employment structuring transactions, which is the basis of on-the-job training. These tasks utilize the analytical abilities developed in business school and provide experience in processing a variety of deals. The experience gained in this way forms the foundation for expanding the associate's role to include developing new business and making presentations to clients. The latter tasks involve client interaction, which eventually will account for over 50 percent of an investment banker's job.

DEVELOPING NEW BUSINESS

Traditionally, large corporations have maintained a close, ongoing relationship with a particular investment bank. In recent years, this type of exclusive client relationship has been threatened by increased competition from other investment banks. This situation has greatly affected the role of the investment banker: When dealing with established clients, sitting by the phone waiting for the client to call for assistance is likely to lead to a loss of business. Instead, bankers now must aggressively maintain ongoing familiarity with a client's financial situation, and have a thorough understanding of new and innovative means of financing, which now are being developed with ever-increasing frequency. The most effective means of maintaining understanding of a client's needs is routine interaction, which is a main function of a managing director and vice president.



Proper execution of this aspect of an investment banker's job will, at best, maintain existing clientele. However, few companies are content with a no-growth policy. Therefore an essential aspect of your job as an investment banker would be establishing new business. Potential clients must be actively approached in your effort to sell the investment bank's services. Usually a managing director or vice president will contact the treasurer or controller of the potential client corporation and arrange a meeting. During this meeting, your team would discuss your firm's capabilities and expertise, and may also explore the financial situation of the prospective client. Sales calls of this nature often require a lot of travel by the investment banker.

As an associate, you would assist the senior member of your firm in preparing for these sales presentations by analyzing the prospective client company. During this analysis, you might use your firm's library to locate information, such as annual reports and lOK's, in order to determine the potential client's historical financial performance, current financial position, and general business description.

Eventually you will be expected to develop effective sales capabilities. Salesmanship is essential in all aspects of investment banking, from establishing client relationships to completing a deal. When a managing director or vice president feels you have developed sufficient capability to be an asset in a sales presentation, you will be asked to accompany him or her. This arrangement will augment your analytical experience with exposure to effective sales techniques.

STRUCTURING TRANSACTIONS AND CLIENT PRESENTATIONS

The structure of a transaction and the subsequent client presentation depend upon what services the investment bank is supplying. The main services-underwriting, private placement, and mergers and acquisitions-each involves different structures and presentations, as shown below.

Underwriting: As mentioned previously, the underwriting process involves the purchase of a corporation's stocks or bonds by one or more investment banking units at a given price, and the subsequent resale of these securities to the public at a higher price. For example, several investment banks and investment banking units within brokerage firms may purchase an issue of five hundred thousand shares of stock from a company for $97 a share, for a total of $48.5 million. Then the investment banks collectively resell this stock to the public for $98 a share, or $49 million, realizing a profit of $500,000.

As an associate, your role in this process would vary depending upon your experience and capabilities. It generally will include company analysis and preparation of written documents. Under the direction of the managing director or vice president who is heading the team, you would compile and analyze relevant information regarding the company, industry, and proposed security to be issued. This information is analyzed to determine the financial strength of the company, including such factors as the debt-to-equity ratio, interest and dividend coverage, and earnings growth and stability. This analysis is often performed with a handheld calculator, though personal computers are now commonly used.

You will also have to develop a clear understanding of the general business of the client company. Such factors as products produced, inventory, raw materials, competition, quality of management, corporate and business-level strategies, and use of the proceeds from the proposed financing must be assessed. In addition, similar information regarding the client's industry as a whole must be assembled.

You would compile this information from a number of sources, including material found in your firm's library, and from securities analysts who follow the industry and company in question. Finally, you might discuss these issues with personnel of the client's company, either over the phone or by traveling to the client's headquarters. The personnel approached would include the treasurer and relevant production managers, accountants, engineers, and lawyers.

You would then communicate the information obtained from this investigation and analysis to the managing director and vice president, along with recommendations on the structure of the financing (stocks or bonds). These recommendations are the result of your analysis, knowledge of financial markets, and conversations with traders and salespeople within the firm. (In some firms, associates now use computer programs to help determine the optimum structure of financing.) The managing director or vice president responsible for the deal then makes the final decision regarding the structure to be recommended to the client.

The managing director or vice president then travels to the client's headquarters to give a presentation based on your analysis. The investment banker is essentially an advisor to the client, and this presentation details the recommended course of action and the rationale for this recommendation. If you have developed sufficient experience in underwriting and have secured the confidence of your superiors, you may be asked to assist in the client presentation. This requires good interpersonal ability, effective communication skills, and a strong personal presence.

After the client approves the investment banker's recommendation, you prepare a registration statement and prospectus to be filed with the Securities and Exchange Commission (SEC). The registration statement formalizes the client company's intention to issue securities; the prospectus is a document which will ultimately be distributed to interested investors during the sale of the issue. These documents include descriptions of the company and the issue offered for sale, as well as the names of company officers, major stockholders, underwriters, and lawyers. Under federal law, all persons involved in the preparation of these documents are liable for damages-such as losses to investors resulting from material misrepresentations of fact in these documents. For this reason, as well as for the sake of the reputation of the firms involved, associates must be exceedingly thorough in their tasks. Mistakes are not tolerated; documents are systematically checked by other associates and superiors before becoming publicly available.

Because input is required from your superiors, other associates, security analysts, traders, and salespeople within the firm, as well as client personnel and outside lawyers, you must schedule your time carefully. Conversations with these people usually take place in the 9:00-5:00 period; therefore the research, number analysis, and writing of the registration statement and prospectus usually take place after 5:00 P.M. Associates often work from ten to fourteen hours a day, including some weekends, to meet the deadlines of underwriting.

While you, as an associate, are compiling information and preparing documents* the senior member of the team begins to form an underwriting group or syndicate. This stage of the underwriting process involves contacting other investment banks and asking them to participate in the deal. There are a number of reasons why investment bankers find it desirable to form underwriting groups. Often a client is issuing equity securities with a face value exceeding the amount of funds the investment bank has available. In this event other investment banks may be willing to join the deal and supply needed additional funds. More important, however, formation of an underwriting group reduces the risk the investment bank faces, the major risk being the inability to sell the securities at a profit after purchasing them from the client. Diversification of ownership reduces this risk, while introduction of additional investment banks to the deal expands the sales force which will offer the securities to the investment community. Therefore, while competition for new business does exist in the industry, a close cooperative relationship is also maintained among investment banks. The associate's role in the formation of the syndicate varies, depending on experience, from distribution of information to participating firms to active involvement in developing potential participants.

In similar fashion, a selling group at an investment bank may also be assembled to sell the securities to the public. Unlike the underwriting group, however, the selling group does not have capital at stake. Instead, they receive a predetermined commission for securities sold.

Prior to the sale of the securities, a "due diligence" meeting is held among the underwriters, client officers, and lawyers, to confirm that the underwriters are exercising proper diligence in offering the securities for sale to the public. The selling price of the issue is then determined by the investment bank's lead manager, a decision which requires experience and expertise. Based on this price, members of the underwriting group decide on their actual degree of participation. Shortly thereafter, public sale begins. Generally, the associate aids the sales force by supplying information about the client company.

Private Placement: As explained previously, this is the sale of securities by a corporation directly to a small group of sophisticated investors with the investment bank acting as liaison. Most companies utilizing private placement are smaller than those active in the public market. If, for example, a corporation wants to raise $10 million, interest among the public may be limited, because the small size of the issue will not create an active secondary trading market. As a result of these limited future trading possibilities, the corporation may have to pay a higher yield than its credit rating warrants in order to stimulate sufficient market interest.

The existence of the private placement market offers the corporation a lower-cost alternative source of funds. The main purchasers of private placements, life insurance companies, have large amounts of funds to invest each year. In addition, they have fairly predictable cash flow and are willing to purchase a security with a thin secondary market if they can receive a higher yield.

The investment banker's role in a private placement is that of advisor to the issuing corporation. Unlike underwriting, the investment banker does not assume ownership of the security, and therefore does not bear the market risk. The fee for this advisory service is negotiated, and is generally a function of the size and complexity of the issue and the credit rating of the client company.

As an associate, you begin work on a private placement when your investment bank is hired by a corporation. You then begin to compile and analyze information on the company. This is similar to the analysis stage of underwriting. However, because the firms utilizing the private placement market are generally smaller and less known than firms in the public market, less written material may be available and securities analysts may be unfamiliar with the company. As a result, more information may have to be obtained from the client's personnel. As in underwriting, analysis in private placement is a time-consuming task requiring long hours.

The information obtained from this analysis is utilized to determine the structure of the financing and to develop an offering memorandum. The offering memorandum is a comprehensive document which provides a picture of the client company's past, present, and anticipated future performance. This document is the heart of the sales presentation when potential investors are approached; it should present the client's company as favorably as possible. As with underwriting's SEC registration statement and prospectus, full disclosure is essential in an offering memorandum. Similar civil liabilities apply for material misrepresentation or lack of due diligence. In addition, investment bankers maintain continuing relationships with portfolio managers of major insurance companies, since they may be involved in future private placements. Therefore, accuracy and thoroughness are essential in an offering memorandum.

The final portion of the package to be offered to potential investors is the structure of the financing. Unlike offerings in the public market, in private placements, a small group of professional investors are approached. As a result of this one-to-one contact, complex financial structures can be developed and explained to them. Using your analysis of the client company's future cash flow, you as an associate would determine a means of financing tailored to the client's needs. (Associates in some firms use computers to assist them in developing these structures, which are typically long-term debt.) Many private placement structures also include "equity kickers," which allow the investor to share in a portion of the company's future profits. A private placement structure also includes covenants, usually restrictions on the future financial activity of the company.

The offering memorandum, including recommended financing structure, is then presented to the client by the managing director or vice president. You may also assist in this presentation if you possess sufficient experience and capability.

If the client approves the investment banker's recommendations, a marketing plan is then developed. Usually only a few potential investors will be contacted, and proper selection is necessary to optimize the chances of successful placement. You as associate would review in-house research data on possible investors and likely discuss the situation with industry analysts, salespeople, and traders. The goal of this investigation is to determine which investors would be most interested in the client and its industry. You must determine just how many companies to contact.

Under the guidance of the senior member of the team, the list of selected investors to be contacted is determined and presented to the client for approval. Once approved, the deal progresses quickly. The associate usually writes a brief memo describing the deal, which is used for telephone contact with potential investors. During telephone conversations you would disclose the client's name and industry, briefly discuss the nature of their business and explain the rate and structure of the proposed financing. If the institution is interested in the deal, the offering memorandum is delivered-usually in a matter of hours. Once these initial contacts are made, time is of the essence, because any significant change in the market will affect the financing rate. Generally, the institution will respond to the deal within one day, with all questions being answered by the vice president or you. The timely nature of this situation reinforces the need for accuracy and thoroughness in the offering memorandum; ideally you have answered most of the investor's questions in this document.

If the institutions' response is favorable, they will discuss with the investment banker the amount of participation in which they are interested. Since more than one investor is usually contacted, participation is on a first-come, first-served basis. Again, due to possible market movement, a favorable response is only valid for a few days. Unlike a public offering, a private placement has a structure open to negotiation, during which phase the investment banker continues in the role of advisor to the client.

The managing director or vice president usually conducts any negotiations with the client at the investment bank's offices. When the negotiations are complete, the investment bankers and the investors will often visit the client's facilities. Once an agreement has been reached, the investors draft a commitment letter stating their agreement to lend. Then the documentation phase occurs; legal documents are prepared and signed. This is followed by the transfer of funds.

Mergers and Acquisitions (MSA): Generally, an investment bank's involvement in M&A activities does not involve raising funds for a corporation. Instead, this aspect of investment banking deals with corporations wishing to expand by merging with or purchasing another company. Due to the variety and custom nature of investment banking activities in this area, it is difficult to describe a representative scenario like those presented above for underwriting and private placement.

As an associate, your main function in many M&A activities would be to locate a suitable candidate for merger or acquisition by the client company. Considering the thousands of active companies in the economy, this task can be expensive and time-consuming. You would be seeking a "good fit" between buyer and seller, and your task would be to develop an understanding of the client company's business and financial situation by analyzing it.

You might begin the search for a possible acquisition candidate by confining your efforts to a particular industry of interest to the client. Review of the client's requirements and financial situation may further narrow the list. This process of elimination is continued based upon the constraints imposed by the client.

The remaining companies are analyzed to determine if acquisition is appropriate. Information on these companies-such as annual reports, lOK's, and analysts' reports-might be available in the investment bank's library. Each company is then reviewed to determine if a favorable integration of business activities with the client company is possible. Consolidated financial reports are prepared and analyzed to determine the strength of the company if such a merger or acquisition were to occur. Additional factors such as possible antitrust violation and major holders of the target company's stock are also investigated. A report on possible acquisition candidates would then be prepared by you and reviewed with the managing director or vice president responsible for the deal.

The managing director or vice president then presents the firm's recommendations to the client. If the client wishes to pursue the matter, the senior members of the team develop a plan for approaching the target company. This plan is implemented by the managing director and vice president after approval by the client. Due to the unpredictable nature of M&A attempts, you as an associate are rarely involved in client interaction or company negotiations.
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