Why Are Investment Bankers Are Paid So Much?

Investment bankers make a lot of money. Straight out of college, these guys are usually paid between $150,000 to $250,000 per year. And if you stick with it until your 40, you can pretty reasonably expect to earn 7 figures if not multi 7 figures. This makes investment banking one of the most lucrative careers in the world and it’s likely the most straight forward path if you want to become stupid rich. The only job that might pay more is becoming a hedge fund manager. In fact, the most successful investment bankers in the world aren’t just deca or centi millionaires, they’re actually billionaires.

Jorge Paulo Lemann, for example, got into investment banking in the early 1970s, and today, he’s worth $20 billion. Similarly Joseph Safra got into investment banking in the 1950s, and he was worth $22 billion at the time of his death. But, likely the most famous or should I say infamous example of investment banking wealth is the Rothschild family. The Rothschild family has been involved in investment banking and other financial services for over 200 years. And according to some reports, the entire family is worth as much $500 billion today.

So, clearly, investment bankers are killing it, but what exactly do they even do and why are they paid so much? BOND FINANCING: Starting of, one of the biggest roles of investment bankers is to arrange financing for companies. This includes everyone from money burning startups like Uber and WeWork to cash rich companies like Apple and Microsoft. In fact, the larger cash rich companies are often the more lucrative clients. But wait a minute, if they have so much cash, why do they even need financing? Well, I have a full video on how billionaires and corporations use debt to their advantage if you’re interested, but in essence, they take out debt to benefit from inflation, reduce taxes, and invest the difference.

Apple, for example, currently holds $103 billion in long term debt. Similarly, AT&T currently holds $180 billion in long term debt. But where does all this money come from? Well, it’s not investment bankers themselves per se, but investment bankers are the ones that help these companies take on this debt. They usually leverage one of two strategies depending on the company’s situation starting with bond financing. If you’re not familiar with what a bond is, it’s basically just a promise to pay back a certain amount of money with interest by a certain date.

This Apple bond, for example, matures in 2027, and in the meantime, Apple is promising to pay a 3% coupon rate or basically a 3% interest rate. One of the factors that make bonds attractive for investors is their stability and reliability. I mean, what are the chances that someone like Apple or Microsoft doesn’t pay back their debt. This option is generally best for companies that are already cash flowing well and can comfortably pay back the debt. Investment bankers usually take care of the back end of issuing a corporate bond. For example, they’ll plan out the bond issuance, they’ll price it, they’ll complete the required documentation, and they’ll market the new bond to potential buyers.

In other words, they take care of the legal side of issuing bonds and ensure that the desired amount is raised as efficiently and timely as possible. EQUITY FINANCING Issuing bonds is just one method to raise money. Another popular method used by investment bankers is equity based financing. This strategy is usually most common amongst startups with little to no cash flow. Since they can’t afford to pay back debt on a regular basis, they choose to dilute their company and offer new stock to the public. Likely the biggest company that was dependent on share offerings in recent history is Tesla.

Given that they didn’t become profitable till 2020, they were forced to constantly offer new shares to raise money. Elon Musk often paid the investment banker fees himself which literally cost him half a billion dollars over the years. This includes $213 million to Goldman Sachs, $209 million to Morgan Stanley, and $85 million to Bank of America. At first glance, this may seem like a ripoff. I mean how hard could it be to fill out a prospectus and file it with the SEC so that the the share offering can be completed. Well, it’s not that hard, but a good investment bank will offer much more than simply completing legal paperwork. A good investment bank will ensure that it’s well worth the clients money.

Here’s the thing, an investment bank’s goal with an equity offering is not just to raise the desired amount of money but also to minimize losses in stock value. For example, let’s say a $100 billion company decides to raise $10 billion through a share offering. In an ideal world, each share of the company should drop by about 10% given that the total number of shares is being raised by approximately 10%. However, if the investment bank prices the shares correctly and is able to get enough buyers on board, they may be able to limit share price losses to 5%. For a $100 billion company, this means preserving roughly $5 billion worth of shareholder value.

Something else to consider is that you also don’t want to leave any money on the table. If you’re able to raise $10 billion and only sustain a 5% loss in share value, this may be a sign that you could’ve raised even more money. You have to be careful though because trying to raise too much money could lead to your stock collapsing. Fortunately, investment bankers are pros at finding the sweet spot between raising money and limiting shareholder losses. And from this perspective, paying a few hundred million to a notable investment bank is well worth it if it can help you preserve billions.

UNDERWRITING: Aside from providing these extremely valuable financing services, investment banks also often act as a sort of insurance company. You see, many of the companies that are looking for financing already have plenty of issues to worry about. And the last thing they want to deal with is a financing deal going wrong. Fortunately, most investment bankers completely eliminate this risk for the company by taking on the risk themselves. Going back to the example of the $100 billion company trying to raise $10 billion, a good investment bank will give the company a percentage of the $10 billion or the full $10 billion upfront.

And it will be up to the investment bank to go out and complete the share offering and recoup this amount. If the share offering goes well and the investment bank is able to raise $10.2 or $10.3 billion, they may be able to keep the excess money depending on the contract. On the other hand, if the share offering doesn’t quite hit the mark and comes in at $9.7 or $9.8 billion, the investment bank may have to pay for the shortfall out of pocket. This doesn’t just apply to equity offerings either. Investment banks generally provide a level of protection for bond offerings as well.

Like an equity offering, with a bond offering, the investment bank will usually pay the company the full amount they want to raise upfront. And it’ll once again be the investment bank’s responsibility to actually go out and sell these bonds. The price of bonds don’t fluctuate nearly as much as stock though. Not to mention, underwriters usually sell bonds for a set price. So, instead of trying to capitalize on market fluctuations, with bonds, underwriters will sell the bonds with a markup. The standard underwriting fee seems to be about $1 per bond or basically 1%.

With smaller deals, investment banks will just take on all the risk themselves, but with larger deals, they usually work with other investment banks to spread out the risk. But either way, the client is usually able to receive most if not all the money they’re trying to raise upfront which is super helpful when they’re trying to focus on running a business. PRIVATE DEALS: Moving onto the last major function of investment banks, we have private deals. Oftentimes, companies don’t want to deal with the public markets due to all the regulation and public scrutiny that comes along with them. Instead, they choose to seek out private financing and cash outs through a method called private placements.

With this method, it’s the investment bank’s responsibility to locate private buyers which usually includes hedge funds and institutional investors like insurance companies or retirement funds. Given that regulatory bodies aren’t that involved in these deals, the primary purpose of investment bankers within these deals aren’t to fill out paperwork or ensure legal compliance. Rather, their primary purpose is to use their street cred to attract private investors. So, choosing a reputable banker is especially important when it comes to successfully completing a private deal. On top of finding private investors, investment bankers are usually the core of setting up mergers and acquisitions.

The investment bankers from either side of the deal will get together and iron out the details of the contract and decide on a fair price. If you’re company is an acquisition target, your investment bankers may be in talks with several potential buyers to hopefully get you the best deal possible. So, that’s basically what an investment bank does, but it’s not all sunshines and rainbows. THE UGLY: Given that investment banks aren’t super entangled with the markets like hedge funds, they’re usually not guilty of market manipulation. But, they do often engage in other questionable activities. For example, one of the biggest concerns with investment banks is potential conflicts of interest.

You see, most investment banks aren’t just investment banks. The vast majority of investment banks on Wall Street also have securities research divisions and trading divisions. Ideally, these different divisions aren’t supposed to communicate with each other and they’re supposed to act independently. But, in practice, we don’t really know how strictly institutions follow these rules. There’s speculation that investment banking divisions and securities reserach divisions often work together to reel in customers. For example, the securities research division might give Tesla a great price target and rate the stock as a strong buy to suck up to them and hopefully have real them in as an investment banking client.

This may not sound like a big deal, but try telling that to the hundreds of thousands of investors that may have been influenced by their strong rating. Another potential conflict of interest is any inside information that investment bankers may have access to. For example, let’s say Tesla wanted to complete a share offering and approaches an investment bank. The investment bank could pass on this info to the trading division of the firm which would of course be insider trading. Aside from conflicts of interest, employees and espeically low level analysts at investment banks are worked to the bone.

For example, the average 1st year analyst ends up working about 100 hours per week. So, that $150 to 250,000 salary that we were talking about at the beginning of the video is actually more like a $70-$80,000 salary. They’re basically just working an insane amount of overtime. The hours do get better with experience, but even at the highest levels, these guys are generally working 60 to 80 hours on a regular basis. And when they’re closing big deals, it’s not uncommon for the VPs and directors themsleves to work 100 hours per week. If this were a fast food restaurant or a retail business, the media would be all over this. But, since these guys are paid a fat salary, no one really bats an eye.

INVESTMENT BANKING: At the end of the day, investment banks are basically the private bankers for large corporations and governments. They help them raise massive amounts of money, complete acquisitions, and they provide them with a certain level of insurance. And considering the size of the money that they’re dealing with, it’s not suprising that they’re paid hundreds of millions if not billions for each project they complete. Working this job isn’t easy though. There’s extraordinary amounts of stress and work involved in raising said billions of dollars and keeping clients happy. So, signing up for investment banking is definitely a case of living to work.

But, if you’re willing to make the sacrifice, it’s no doubt one of the fastest ways to get stupid rich. Would you guys consider becoming an investment banker? Comment that down below. Also, drop a like if you wish you had the salary of an investment banker. And of course, consider checking out our international channels to watch our videos in other languages and consider subscribing to see more questions logically answered.

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