Investment banking and private equity represent some of the most essential banking institutions within the finance sector.
Most people cannot differentiate between the two as at face value they seem similar but in reality they are meant to serve different purposes, to target different markets, and to pursue different strategies in making profit.
Investment banking is the part of banking which helps companies, governments, and other institutions raise funds and manage complex financial transactions.
They issue stocks, bonds, and any other kind of security and also advise the companies on mergers and acquisition.
Thus, they serve as an intermediary between a firm that needs capital and investors who are in a desire to buy securities.
Private equity primarily concentrates on direct investments in companies. It generates funds from various institutional investors, such as pension funds and insurance companies, or from rich individuals like HNI and UHNI, and then uses the funds to invest in buying stakes in ownership of companies.
They generally target companies that are not listed on a stock exchange.
Investment banks provide services like-
- Advisory services: Advise companies, government and other institutes to make decisive financial transactions,
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Capital market services: Help companies raise money by issuing new stocks or bonds and they also facilitate buying and selling of financial products for their clients
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Help clients manage financial risks by analysing company profile and market trends.
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Provide underwriting services i.e: they buy all the shares of the companies themselves and then sell them to the public or they sell the shares directly to the public on behalf of the company and earn commissions on each share sold.
Private Equity provide services like-
- Investment Strategy: Private equity firms raise money from high net worth individuals (HNI) or ultrahigh net worth individuals (UHNI) to invest in companies with the goal of increasing companies value over time. Then actively manage companies’ performance to improve its profitability. They may also buy entire companies and implement strategic changes to enhance profitability.
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Active Ownership and Management: Private equity firms do not provide services such as advising companies like Investment banks; rather they take the more hands-on approach by investing in a company directly and bringing in new management teams, they even change companies business strategies and implement operations that will improve the company’s value.
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Exit Strategy: Private equity aims to get its profits by selling the companies in which it invests within a few years, normally within 3-7 years, to make a profit. They either sell the company to another buyer or take it public through an Initial Public Offering (IPO), or they would merge it with another company.
Investment banking (Sell-Side) generally represents companies that are willing to raise money by selling securities (stocks or bonds).
The Private Equity (Buy-Side) represents the side that purchases investments. Investment bankers prepare financial analyses, market the securities to investors, and help the companies raise funds.
While Private equity firms use investors’ money to buy stakes in companies to grow their value over time. Investment banking, therefore, uses its capital mainly in underwriting securities-buying and then reselling stocks or bonds-and to facilitate trades.
Private equity pools capital from investors to buy companies with the intention of improving them and selling them off for a profit after a few years.
Investment banking conducts more short-term deals. For example, when a company intends to offer shares, they hire an investment bank and float the shares within a week or a month.
Private equity, on the other hand, invests for extended periods usually holding a firm for 3-7 years and then selling it in an attempt to recover their money after the performance of a company has been enhanced.
Investment banking does not invest in equity in companies; rather, it collects fees from customers for giving advice, underwriting the issuance of securities, or arranging deals. Private Equity, on the other hand, acquires significant portions of control in companies through those acquisitions and exercises control over the company’s management and its business strategy.
Investment Banking is less risky because they don’t own the companies; instead, they just advise clients about various investment opportunities and for that, they charge a fee based on deals they close.
In Private Equity, risk is very high because they invest on the ownership of the companies and are directly involved in the functioning of those companies. If the companies failed to perform well, they could lose money, but if the investments succeeded, the return can be much more profitable.
Investment banking involves a large number of clients, ranging from corporations and governments to other institutions that seek to raise capital and are willing to invest in large-scale financial transactions.
Whereas Private equity focuses more on its primary dealing with the institutional investors and high net-worth individuals ready to provide funds to the private equity firms to take up the equity holding in the various companies.
Overall, investment banking and private equity are related closely because both of these institutions play an important role in the financial market, which gives different services to its clients.
Investment banking which mainly focused on providing financial transactions to its clients by charging some fees for its services but without taking any ownership of it. Private equity raises money from HNI or UHNI and thereafter creates value by taking ownership of stakes in various companies and actively managing them to bring a higher return.
The two institutions often interact with each other in the financial market; for example, when Investment banks help private equity firms raise money by issuing bonds or stocks to finance the acquisition of a company or when Investment Banks might be hired by private equity firms to advise them on sale or to launch an IPO for their company.
Thus there is a key difference between both investment banking and private equity and one should know the difference between them to understand the best options for your goals and preferences.