How Do Investment Banks Works? (#73)

How Do Investment Banks Work?

What Are Investment Banks?

An Investment Bank is an organization that partners with businesses to help them raise capital — while taking on much of the risk involved in that process itself.

That definition will make a lot more sense by the end of this article — let's walk through what investment banks actually do.

What Do Investment Banks Do?

Say a company wants to raise funds quickly. It can approach an investment bank and ask it to find investors on its behalf.

The investment bank goes out and finds suitable investors for the company, and — critically — guarantees both sides of the deal: the company that its shares (or bonds) will sell, and the investors that the company will follow through on its end. In doing so, the investment bank takes on real risk as an active participant in the deal, not just a matchmaker.

This makes the investment bank a genuine intermediary between the buyer (investors) and the seller (the company). If either side fails to hold up their end, the investment bank is on the hook to cover the resulting losses — since it took on that risk directly.

→ Related: What Is a DRHP/RHP?(#3) — investment banks play a central role in the IPO process this document is part of.

This entire function is known as underwriting: guaranteeing that a security will actually be sold (from the company's side) and actually be bought (from the investor's side), with the investment bank absorbing the risk if something goes wrong.

Mergers & Acquisitions

Beyond raising capital, investment banks also play a central role in mergers and acquisitions (M&A):

A merger is when two companies combine into one.
An acquisition is when one company buys another outright.

In both cases, investment banks typically serve as the intermediary — advising on deal structure, valuation, and negotiations between the parties involved.

(Worth knowing: underwriting and M&A are two of the most visible functions of investment banks, but they typically offer other services too — including sales and trading, asset management, and financial research. This article focuses on the two most fundamental ones.)

Just How Powerful Are Investment Banks?

A good way to gauge their real influence is looking back at the 2008 financial crisis — investment banks weren't the sole cause, but they were deeply involved. Lehman Brothers, the 4th-largest investment bank in the U.S. at the time, collapsed into bankruptcy on September 15, 2008 — still, to this day, the largest corporate bankruptcy in history.

→ Related: The Global Recession/Crisis of 2008(#49), What Is Bankruptcy? What Happens When a Company Goes Bankrupt?(#20)**

That covers the core functions of investment banks — underwriting and M&A — and just how much influence they genuinely hold over the broader financial system. Thanks for reading.

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