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Chapter 1: The Securities IndustryThe recent banking reform legislation removed the last impediments that prevented securities firms from entering the banking business and banks from entering the securities business. This change has unleashed a torrent of new competition from outside the securities industry to compete with the traditional securities firms. Who would have guessed 10 years ago that Travelers, Citicorp, Salomon Brothers, and Smith Barney would all merge into one financial super market?
This increase in competition has caused almost every department within the major full-service securities firms to change the way it does business. The best way to start our review of the securities industry is with a brief overview of the various departments, their functions, and how their business has changed over the last decade.
Investment Banking Department
The purpose of the investment banking department is to advise governments and corporations on various financing and strategic issues. For example:
1. A rapidly growing privately owned company wants to raise some equity capital in order to expand its operations. The company would hire an investment bank in order to help it make several decisions regarding how to proceed. Among the issues to be considered are:
- Should it sell its stock to a limited number of accredited investors (referred to as a private placement) or should it sell its stock to the public at large (referred to as a public offering)?
- If the stock is to be sold publicly, should it be sold in large blocks to a few investors or in small blocks to many small investors?
- In which country(s) should the stock be sold?
- At what price should the stock be sold?
The investment bank would then help the firm prepare the necessary documentation for either the private or public offering. The investment bank would also assist with the actual sale of the stocks or bonds.
2. A municipality wants to build a new sewer line and would hire an investment bank to help it decide whether:
- To borrow the money by selling bonds to a limited number of accredited investors or sell the bonds to the public at large.
- To issue fixed rate or floating rate debt.
- To issue short- or long-term debt.
3. A large public company changes its strategy and wants to sell off several of its operating divisions that no longer fit within the company's strategy. The company would retain an investment bank in order to help it value the divisions it wants to sell off and find potential buyers to sell off the unwanted divisions.
Naturally, before a corporation's chief executive officer is going to entrust an investment bank with something as important as the initial public offering of its stock or advice on a potential merger or acquisition, he or she is going to have to be convinced as to the professionalism and expertise of the bankers who will be working on the project. Therefore, investment banks try to staff themselves with the most highly trained professional people they can find. Generally, an MBA degree and 5-plus years of business experience are a prerequisite for even being considered. In addition, most investment banks have multiyear internship programs for their new hires.
The major change in the investment banking business is "globalization." As the economy has become global, companies have also become global. Today, a large U.S. multinational is just as likely to issue bonds denominated in pounds as it is in dollars and is just as likely to make an acquisition in Seoul, Korea, as in Sioux Falls, Iowa. Therefore bankers have to have a global perspective and expertise.
Venture Capital/Private Equity
The venture capital division invests in small private companies in exchange for a partial ownership interest in those companies. Typically, these companies are young, small, and sometimes have little more than "an idea." Every venture capital investor hopes to invest in a small company that grows very rapidly and can eventually be sold to a larger company-or be taken public. Of course, only a small percentage of the companies that are started become huge successes, so venture capital investments tend to be quite risky. Of course, if the money is invested in the right companies, the returns can also be quite spectacular.
The money this division invests in these small companies usually includes the firm's own capital, as well as money it raises from investors. These investments are usually structured as partnerships and are offered only to investors with substantial net worth. The big change in venture capital over the last 10 years is the increase in the availability of money to fund small companies. One of the big advantages of business in the U.S. is that venture capital is readily available...