Private Equity vs. Investment Banking

Private equity and investment banking both help businesses find, develop and grow capital, but each does it in a different way. A private equity firm buys assets itself, looking to grow those assets and profit off of each down the line when they are sold. An investment bank primarily sells assets for another party. While investment banks can also hold portfolios, their main business model is to find investors on behalf of corporate clients and they make money based on a combination of client fees and commissions. If you’re looking to exit a business or raise capital, you may benefit from speaking to a financial advisor.

What Is Private Equity?

Private equity firms are investment firms that specialize in assets not listed on public markets. They take their name from this investment strategy because these firms specialize in buying equity of private assets. This generally means any and all assets that aren’t regulated securities issued under SEC rules for public purchase. So, for example, where a mainstream investment firm will invest in stocks and bonds, a private equity firm might invest in real estate or in equity of a business with high-growth potential.

While private equity firms can and sometimes do invest in early-stage startup companies, this is relatively uncommon. Instead standard private equity firms tend to invest in struggling companies that they can rehabilitate and either operate long-term or eventually sell in five to seven years. Venture capital firms tend to provide capital to those early-stage startups.

While private equity firms can and sometimes do invest in assets other than businesses, this is again relatively uncommon. In most cases, hedge funds invest in a broad spectrum of assets while private equity firms focus on acquiring and developing businesses.

In all cases, the business model of a private equity firm is as a buyer. They purchase assets, typically companies. They make their money through the return on those assets, such as any share in the company’s profits or their capital gains from selling the assets later on down the road.

What Is an Investment Bank?

When a company wants to sell stocks or issue bonds, it can utilize professionals that are in the investment banking industry. Investment banks specialize in helping companies raise or move capital. This is as opposed to a depository bank, the other main form of banking, which specializes in holding capital for companies and individuals. Investment banks do this in several different ways.

One of an investment bank’s most common services is to issue and sell shares of stock on the primary market. A company can either issue shares through an IPO when it sells equity to the public for the first time, or through a secondary issuance when a currently traded company releases additional shares. In both cases, an investment bank helps the company through the legal and financial process of creating those shares. Then it sells those shares on behalf of the company.

Investment banks also help companies raise money through debt. In this case, the bank helps the company prepare bonds to issue. It then sells those bonds on behalf of its client.

Investment banks tend to handle virtually any matter in which a corporate client wants to find or move capital. Most often, this includes handling mergers and acquisitions. For example, if a corporation wants to sell itself, it might approach an investment bank to find a buyer and structure the deal. Or if two companies want to merge, an investment bank will manage the process.

Investment banks work hand-in-hand with law firms to manage all of the financial work that goes into raising or managing capital. They handle regulatory issues, internal audits, market analysis, setting appropriate prices, interest rates and much more. Typically an investment bank will also serve as an underwriter for any securities that their client will issue.

Investment banking is somewhat asymmetrical to private equity. In one sense, an investment bank sells assets while a private equity firm buys them. However, an investment bank does much more than just sell assets. Many of an investment bank’s deals do not involve selling securities, but rather involve market analysis, market making, financial management, regulatory management and other matters.

While an investment bank does make a lot of its money by selling assets, most of its money comes from the fees that it charges to clients. This makes the business model somewhat more stable if potentially less individually profitable than with a private equity firm.

Overall, the biggest difference is who each time of firm works for. A private equity firm works for itself, or in most cases for its investors who trust them to make money on each investment. An investment bank works for a third-party business that hires them to complete a specific purpose, such as selling their stock or equity.

The Bottom Line

Private equity firms buy assets that aren’t listed on the public markets and profit off the returns from those investments. In most cases, they buy and sell companies. Investment banks help companies raise capital and sell securities on behalf of their clients. They make their money off a combination of commissions and fees. Each has a specific purpose that involves financing businesses, but each has a role that is unique compared to the other.

Tips for Investing

If you’re looking to invest in new markets or raise money for your business, a financial advisor can help you understand how it all works with your financial goals. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Only individuals with a lot of available capital can invest in most private equity firms. In fact, many only take institutional investors. Most people can consider alternative investments if they are looking for something outside the norm.