What is an investment bank actually paid for?Easy

For a list of buyers and the credibility to call them, for underwriting risk with its own balance sheet, and for being wrong in public if it is.

3 min read · 515 words

The question is asked sceptically and it deserves a straight answer. There are three things being bought, and only the first is what people picture.

One: the list, and the standing to use it

Selling a company means knowing which twenty buyers might want it, which of them can fund it, which will actually engage rather than gather information, and being able to telephone all of them credibly in the same week.

That is not knowledge anybody can look up, and it is not something a company does often enough to build. It is also what makes the difference between one bidder and two — and two bidders is where most of the price comes from.

The same applies to a bond or a share offering: the product is the set of investors who will take the risk on the day, and the record of having placed things with them before.

Two: standing between the issuer and the market

In an underwritten offering the bank commits to the price before the money is in. If demand disappears between the commitment and the settlement, the shares or bonds are its problem. In a leveraged buyout the underwriting bank funds the purchase and then has to sell the debt on — and a loan it cannot sell sits on its own balance sheet.

That risk is real and it has been paid for in cash more than once. A commitment letter is not advice; it is a balance sheet.

Three: being accountable in public

A fairness opinion is signed. A prospectus names the banks on its cover. When something in it is wrong, they are among the people who can be sued, and their name is attached to the transaction permanently.

The structure says more than the amount

A typical arrangement has three parts, and each exists to solve a specific conflict:

• A retainer, paid whether or not anything happens. Small, and its job is to make the adviser's time real rather than free.
• Announcement or milestone payments, which pay for work that has been done regardless of the outcome.
• A completion fee, which is most of it.

The last one is the informative part. An adviser paid mostly on the day it closes has an interest in it closing — including on terms the client might otherwise have walked away from. That is not hidden; it is the structure, and the retainer buys back a little of it. Knowing it is the point.

Who pays for the research and the sales coverage

Historically, the same fees paid for research that reached investors free. The 2003 Global Research Analyst Settlement in the US separated research from the banking business that funded it, and European rules later required investors to pay for research directly. That is a structural change worth knowing about when you read anything published by a bank.

What you cannot buy

Certainty. A regulator, a court, a shareholder vote and the funding market are all outside the mandate, and what kills a deal counts how often each of them is what decides.