“I Don’t Want to Do Equities”

I am a big fan of “giving back” to aspiring financiers, in large part due to my altruistic nature. However, another reason is to encounter dunces and laugh at them. When I get a few in a row of the latter, I grow weary of helping students break into investment banking and lampoon them on this website instead.

I can tell you that one of the most misunderstood topics in investment banking is equities. Students think that working on equity issuances does not get you “deal experience” and accordingly cannot get you into the private equity gravy train.

Tangentally, we have already discussed in the past that 90% of bankers that exit into private equity are probably worse off than if they stayed in banking as they make less money and do not work measurably less – although you could give them credit for getting to do slightly more interesting work. Let’s be real, no six year old dreams of doing IRR math all day and diligencing whether or not a factory has abestos – you went into finance for the money and now you’re lying to yourself.

This equity deals are bad mentality is perpetuated by the phrase “equities in Dallas” from Liar’s Poker, a classic but dated book, where schmucks are shipped off to non-prestigious divisions – something that still definitely happens on the trading floor today (if they don’t just fire you). I was reading somewhere I forget that interviewees should not say “I want to do IPOs” because they might get slotted into ECM.

Now, I personally think that getting in on huge IPOs like Alibaba, Xiaomi or Saudi Aramco would be enriching from the perspective of a corporate finance professional – but let’s ignore all that and focus on what matters.

Banks need equity to make money. Equity is what gets you paid.

Investment Bankers Love Equity Issuances

So assuming that you cannot get into Onex or Blackstone type firms, you are going to learn to love equity. A year without equities is a quiet year which means a crap bonus. The smaller your firm and the less robust your capital markets platform – and by that I mean the less fixed income, vanilla derivatives and exotics your bank’s capabilities are, the more equity matters to you.

You can have plenty of M&A in a year and get sole advisory credit and fees – but know that for the largest deals, the fee percentage shrinks substantially. For a 40 billion dollar deal you might get 35 basis points (bps) – substantial, but how often do those come around? Winning the M&A is almost a loss leader to ensure that you win the financing, where the banks can make materially more on a transaction.

If you lead the bridge loan and collect immediate upfront fees before extinguishing the debt and leading the debt and equity financing before layering on floating-to-fixed cross currency interest rate swaps on the debt, you have made the bank immense sums of money. The catch is – you don’t necessarily have to lead the M&A to lead the financing.

You certainly work for the M&A too – to consummate a transformative deal of this nature, a casual stroll around the office will reveal that people are sleeping under their desks unshaven and with red bull cans and McChicken wrappers strewn throughout the floor.

ECM Fees Versus DCM

Debt capital markets is an easier process, but the fees are abysmal compared to equity. For investment grade debt you will get 25 – 75 bps in issuance fees based on tenor and size. For high yield you can get 200-300 bps along the same characteristics. In addition to this, the buy side is more savvy on this front – although there certainly are less than astute debt investors that manage large portfolios, while the math is more difficult.

But equity is the rainmaker! If markets are frothy – that is stocks are trading at high valuations – and investors have an eye for speculation, investment bankers get to hop on the good times express.

For equity deals, fees will start at 200 bps (2%) for agency deals that are underwritten under a best efforts arrangement. If the equity does not clear, the bank is not saddled with the risk of holding the stock. However, 200 bps is a lot and that is just the bottom of the equity pay scale.

For bought deals or fully underwritten deals, where the bank does take on the risk of a hung deal (stock does not clear), they buy it at a fair discount to the last trading price AND charge a hefty commission – sometimes 5-7%. These are especially popular in Canada, and the bought deals make the banks enormous amounts of money. What’s 5% commission + 3% discount of $1 billion dollars? Do the math.

With equity, your bank does not necessarily get to lead the whole deal. It has to be syndicated for two reasons – 1. your bank may not have the sales force and relationship required to move huge issues; 2. clients have a number of relationship banks (corporate banking) that they need to pay – and ECM is the best way to pay. However, the fees and ease of execution will more than make up for not leading the whole block.

Equity Issuance Work Streams are Easier

ECM deals are an experienced banker’s dream. Every year, fresh, doe-eyed investment banking analysts will get excited to be staffed on the crappiest buy-side M&A files with the most feared MDs. The senior analysts chuckle as the new blood eagerly begin to self-flagellate. Three months later, the ones that realize that Apollo will never come a calling dream of equity – low work, huge fee.

For seasoned equity issuances (companies that are already public), investment bankers just change some names and dates and refresh some charts before their work is done and lawyers take it from there. As the issuer already knows the process, they do not need to be handheld as much – nor are they usually as demanding.

IPOs are generally not that much more difficult (there are exceptions) as you can take a boilerplate S-1 and change text. Also, if you lead the IPO and do a good job with pricing, you tend to lead the secondary/seasoned offering.

You can pump out one offering after another, and usually for crappier companies once one industry peer issues it starts a wave of issues – and you definitely want to be in a bank that was lead left (the lead bank in the transaction) as it means you are well placed to lead the next few issues.

This does not mean that you want to be in ECM, however – you want to be a coverage banker in an industry group that happens to be hot at the moment. ECM is execution, the industry group holds the relationship. At a higher level, the coverage banker always gets paid more thant he execution banker.

Equity Makes it Rain and Case Studies in Bonuses

When equity is hot, everyone gets paid – junior staff get better bonuses and get more perks in the form of dinners and events. Senior staff are in a good mood because they are getting millions of dollars and will in turn treat the junior staff better.

Curiously, the only time it is worthwhile to be working at a boutique that is not of the Moelis/Evercore persuasion (the Elite Boutiques) is when they are first movers in a new space that major investment banks will not touch because of a conservative legal team and reputational risk (marijuana stocks, blockchain stocks) or big into junior resource stocks (oil and gas and mining companies that you should NEVER touch) and that subsector is hot.

For the recent marijuana stock equity raises, you can be assured that managing directors at boutiques have made millions of dollars under their compensation structure.

For the mining boom during China’s huge output from 2011 to 2013, associates at mining boutiques were making close to a million dollars (for reference they would make 250-400 at a bulge bracket). As the junior miners are less sophisticated and the retail investors non-plussed about real valuation concerns and with an eye for speculation, there were associates that knew the equity deal process cold and could just execute on boilerplate agreements over and over again.

When oil was over $100 before 2008 and in 2014 as ISIS was marching on Baghdad before that OPEC meeting while levered and cash flow negative oil and gas companies were in high demand, managing directors at tiny boutiques were clearing in excess of $10 million per annum. A good time to be had by all.

Better Exits to Growth Markets

Banking to private equity is cool but banking to banking somewhere else is also cool. Other than the US and Europe, DCM is not a big thing. In Europe as well, debt is often bank or term loan debt as major family owned conglomerates eschew bond issues for the flexibility and cheapness of the banks.

ECM, accordingly, is where things are happening in China and emerging markets until debt markets mature – which may be a while still. Leverage levels are low and ECM bankers are the ones getting paid – so keep that in mind.