How Investment Banks Operate In ECM Markets
Investment banks may be either standalone institutions or specialised departments in a full-scale bank. They provide advice to governments, corporates or high-net-worth individuals on financial transactions related to raising funds from capital markets; they derive their profits by charging fees on the services they offer.
Investment banking services may be broadly segmented as equity capital markets (ECM) and debt capital markets (DCM). Both provide advice to clients on raising money from the market, but their approaches are different. While the ECM raises capital for the client through equity on a long-term basis, the DCM raises funds through debt on a short to medium-term basis.
In a company, the term equity refers to its shares. Holding a share is like owning a portion of the company. Equity capital or residual capital is raised by offering shares to investors or shareholders.
Functions Of The ECM Team In An Investment Bank
The ECM team in an investment bank raises funds by dealing in shares in the stock market and generally performs the following functions:
Initial Public Offering (IPO)
When a company decides to raise money from the stock market by launching its shares for the first time, it is called “floating” the company or launching its IPO. Since risks are higher in shares, returns are also generally high. Therefore, ECM teams in investment banks need to be detail-oriented and professional in their approach to launching such ventures for clients.
The process starts from meticulous planning by the team and the client on the amount required to achieve their goals, the configuration of shares and the proposed target investors. ECM teams also do “roadshows” to potential investors in various locations to increase their interest in the launch.
When the share options are shared with potential and chosen institutional corporates, the books are opened to create interest. This helps in getting market feedback on the price of the share and in arriving at a suitable evaluation. This process is known as book building.
If a single investment bank is organising the venture, it is called the book runner. A book runner is solely responsible for the results or the outcome of the offer. Therefore, the remuneration or fees on the transaction is also high.
If a group of investment banks jointly float a company, they are called a syndicate. In such arrangements, just as responsibility, results and workloads are shared, so is the remuneration.
Once the company has been floated for more than a year, it may require further capital from the market. Here, the main job of the ECM team is to market the company, as the capital market decides on the issuance share price.
When a public listed company faces a cash crunch, it may issue discounted additional stock in the market to meet immediate financial obligations. This is another crucial job of the team.
This kind of stock trading is negotiated by the ECM team in investment banking; here, a negotiated sale is conducted between the buyer and seller without affecting the market’s demand and supply pool. Without this negotiation, such huge trades can cause a tsunami in the share market.
Registered Direct Offerings
When trading of the stock is offered to a handful of listed investors who were carefully chosen following negotiations, this is known as registered direct offering. These investors are called registered investors. The investors may include pension funds, fund managers and insurance. This stock is not offered in the open market.
When shares of the founder shareholders are traded in the market to offload some of their stock, it needs to be closely watched by the ECM investment banking team, as it may cause quite a change in the primary shareholders’ list.
Benchmarks considered by investment banking ECM before suggesting equity financing
If a company is a solo operator and does not like discussing and voting for major decisions, it needs to think twice before opting for equity financing. This is because, in such arrangements, profit is to be shared and decisions are to be respected.
But if a company has problems related to creditworthiness, this is an ideal option for the company: no loans, no monthly burdens of interest and the freedom to channel funds as required.
Share prices or stock markets change in line with market demand and supply; therefore, returns are never guaranteed, making equity holdings the riskiest of all investments. Therefore, when an investment bank takes responsibility of managing equity capital through its ECM team, it takes on a demanding obligation not only towards the company but also to general investors. Therefore, it is of utmost importance that it operates with foolproof blueprints.
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