Financial statements can sometimes be the only things investment bankers can trust. Company management has a big incentive to puff their chests and try to act like their companies are performing better than they really are. And even investors can be misleading, aggravating for change at the company even if things are going fine.
But despite the value of financial statements to investment bankers, these documents, too, need to be looked at with at least an ounce — and at times pounds — of skepticism. Although it’s not common, executives at companies sometimes attempt to fudge the numbers to mislead investors or (gasp!) investment bankers. When a company’s performance is faltering, and investors are likely to be disappointed, some dishonest executives and accountants may decide to distort the financial results through liberal interpretations of accounting or outright fraud.
Individual investors, who may not take the time to read the financials, can often fall for such accounting gimmicks. But investment bankers are held to a much higher standard and are generally considered to be above the tricks. In Chapter 16, you find out some of the ways investment bankers can look for accounting sleight of hand in the financial statements and avoid getting duped.
Making adjustments to financial statements for comparability
Accountants don’t like surprises. Some accountants may be startled if a pen they thought had blue ink turns out to be black. But although the predictability of accountants may be subject for good-natured ribbing at cocktail parties, that uniformity is essential in financial analysis.
To accurately compare and contrast companies in different industries — something investment bankers have to do frequently — the companies’ financials must be subject to the same ground rules. Accounting rules usually do a pretty good job aligning the financials of different companies. Generally accepted accounting principles (GAAP) are a set of accounting standards that attempt to create a measure of performance that is somewhat comparable across industries.
But despite the value of GAAP, it’s up to investment bankers to take greater efforts to make sure that the financial results of companies are truly apples-to-apples comparisons.
In Chapter 17, you find out ways that investment bankers are able to modify and adjust the financial results of companies to make their results comparable. These techniques, as well as everything you read about in this book, all come into play when you try your hand at an investment banking analysis case study in Chapter 18.
Chapter 2
The Purpose of Investment Banking: What Investment Bankers Do
IN THIS CHAPTER
Investment banking is the grease that oils the capitalistic machine. Businesses, entrepreneurs, governments, schools, and other institutions that hope to build and expand need cash to make it happen. But in the financial version of the chicken-and-the-egg dilemma, sometimes the people with the great plans don’t have the cash to get started.
And that’s exactly where investment bankers come in. Investment bankers find ways to put together investors with money, who would like a return on that money, with the people building projects.
Investment bankers play an interesting role in that they’re usually just the money people. The officials from the city or government are in charge of the project, be it building a bridge or building a power plant. But investment bankers are the critical financial players that make sure the project is adequately funded, but at the same time, generates adequate returns to make the investors happy.
This chapter isn’t designed to get into the nitty-gritty yet. The gory details of what investment bankers do comes in later chapters in this book. This chapter is more of a bird’s-eye view that shows you some of the ways investment bankers get involved in key financial transactions. You’ll read examples where investment banking plays a big role in making things happen with companies and investors. Perhaps one of the most high-profile ways investment bankers are seen in modern finance is in mergers and acquisitions (M&A), transactions where big companies decide to buy a rival or another company with advantages it would like to have. You also find out about leveraged buyouts (LBOs), which are unique transactions where buyers use large amounts of borrowed money to buy a company. Another primary driver of investment banking activity are initial public offerings (IPOs), where companies raise money by selling pieces of ownership to the public for the first time. Tying many aspects of investment banking together are the disciplines of research and valuation. Lastly, in this chapter, you get a sense of the importance of trading at many investment banking units, and appreciate the risks and potential rewards.
Putting the For-Sale Sign on Corporate America
Investment bankers are the ultimate corporate matchmakers. They’re like the friends you had when you were single, who were always trying to fix you up. When companies or investors are on the prowl to buy other companies, or put themselves up for sale, they often turn to investment bankers for a hand. We cover the M&A process in more detail in Chapter 3, but for now, know that investment bankers play several important roles in the M&A process, including the following:
Performing due-diligence services: Investment bankers can help the buyers and sellers determine a reasonable price for the company. The value is put on the company by comparing with other companies that trade on stock markets or based on the fundamental profitability of the company.
Matchmaking services: Investment bankers are only as good as their source list. When a company is looking to do a deal, investment bankers start working their personal relationships trying to find companies that may be in play or open to a bid.
Lining up investors: When a company is looking to raise money by selling securities, the deal hinges on being able to actually find buyers for those securities. Investment bankers are often looked to in order to find investors willing to buy the securities.
You discover the wide array of ways investment bankers help put companies on the market in the rest of this section. These deals range from everything including mergers and