Why Investment Banks Make So Much Money
It’s a question as old as Excel itself.
“If investment banking is not that hard, why do you make so much money doing it?”
Sure, the hours are terrible. And as an Analyst or Associate, you’re respected just slightly more than a primate.
You’re always at the mercy of the client, sacrificing your spouse, children, friends, and social life in the process.
It’s extremely competitive, requiring a top-notch education, stellar grades and previous finance summer internships.
And you need to sit motionless in front of a monitor for 28 hours at a time.
All of these points are valid – but they do not directly explain why bankers make as much money as they do.
What Bankers Actually Do
When I say “banker,” I don’t mean Analyst or Associate and I certainly don’t mean Models and Bottles AJ; I mean a Group Head / Managing Director / BSD-type character.
You know, Ari Gold.
Bankers sell companies just like Ari Gold sells movie stars. And they get paid the same way as well: commission.
Just like movie agents, the higher the price, the more investment bankers can earn in commissions.
Ari Gold Wannabes
Think about a used car salesman: they’re paid a commission based on the profit earned on the cars they sell.
So let’s say they sell a car for $15,000, of which only $500 is profit – they might earn around $100 (20%) from that.
Not bad, but they’re going to have to sell a lot of cars to make bank.
Now think about another variation of Ari Gold: real estate agents. They’re selling much higher-priced items, ranging from hundreds of thousands of dollars to millions of dollars or even more than that.
They might only make 5% or 6% on that, but 5% of $1 million is $50,000. Not bad for one sale.
But now picture the investment banker: he sells companies for millions, hundreds of millions, or even billions of dollars.
Deals worth less than $1 billion might come with a 1% commission, while deals worth more than that will scale down to around 0.1%.
But even 0.1% of $50 billion is… $50 million.
So that’s part 1 of why investment bankers make so much money: high-priced items with high commissions.
Other Financiers
But if you just stopped there, you might think that commercial bankers and wealth management guys would make bank as well: they manage billions and also earn commissions on their funds.
However, those commissions are lower than what bankers get and they have significantly higher expenses as well.
Expenses – What Expenses?
So now we arrive at the second reason why investment bankers make so much money: the margins.
Think about all the expenses that a commercial bank might have: you have to pay for all those physical branch offices, ATMs, tellers, checkbooks…
And you can’t exactly charge someone a 1% fee on $1 million just for depositing it in a checking account.
People Are Not An Asset, But They Are An Expense
Banks, by contrast, have almost no real expenses.
All you need to advise a company on a deal is a small office and 3-4 bankers – no factories, no manufacturing costs, no hordes of employee salaries to pay.
They do have to pay for office maintenance and other fees, but they’re tiny next to the expense profiles of “real” businesses.
Travel? Food and hotel expenses? On a deal, the client pays for those.
And even if the client didn’t pay, these expenses are nothing next to multi-million dollar fees.
Investment bankers make a lot of money because they sell companies for huge amounts of money while earning a generous commission and spending hardly anything in the process.
And what do they do with that generous commission?
Traditionally they have paid out 50-60% of revenue to employees in the form of salaries and bonuses: and that’s why investment bankers make so much.
Private Equity & Hedge Funds
The same principles apply to hedge fund and private equity compensation: both make a lot of money because a lot of money passes through their fingertips and they take a good chunk of it without spending much.
Private equity firms and hedge funds earn money from a management fee – what they charge to cover expenses and “manage” funds – and carry – a percentage of their return on investment.
The typical management fee at these funds is 2% – so at a $10 billion fund, you could earn $200 million just for sitting around and “managing” the money.
The carry is dependent on performance: funds typically charge 20% on their returns. So if they invest $100 million and turn it into $200 million, they would earn $20 million and then distribute $80 million to their own investors.
“2 and 20″ is the term used for this structure.
A few funds perform extraordinarily well and make most of their money from the carry – but plenty of under-performing funds actually earn more from the management fees.
Wait, But Shouldn’t the Markets Be Efficient?
If you’ve studied economics, you might be wondering how these types of business models with high marginal profits can last.
Shouldn’t the markets be efficient and force fees, salaries, and bonuses down?
Nope.
Applying economic theory to this scenario is problematic because you can’t quantify reputation and relationships, both of which are essential to advising companies.
It can take 10-20 years to become a trusted advisor to companies – so yes, marginal expenses are low and profits are high, but the barriers to entry are extremely high as well.
Will It Last?
Let’s look at private equity firms and hedge funds first.
In the old days, the “2″ part of the “2 and 20″ fee structure allowed investors to “keep the lights on” before they exited any of their investments.
It was never intended to generate more profit than the firm’s actual investments.
And most investors in hedge funds and private equity firms would say that they’re greatly over-paying for these management fees.
But who will be the first to propose lower fees?
As long as the investing process requires skilled individuals with years of experience, fees are unlikely to come down.
The only way this will happen in the future is if computerized investing takes over – but while that has happened on the flow trading and prop trading side, it’s not viable to let computers run $50 billion deals.
On the investment banking side, there’s even more of a case to be made for lower fees: in a lot of cases, bankers simply don’t add that much value.
It seems ridiculous that banks can often charge 7% on IPOs and 1% on M&A deals given that they take on little risk most of the time.
But once again, we come back to the same problem as above: who will be the first to undercut everyone else?
And that’s why the fee structure will continue: no one wants to accept lower fees if they don’t have to, and the high barriers to entry prevent disruption.
If The Market Were Efficient…
If the market were 100% efficient, fees would come down, firms with sub-par performance would go out of business, and companies would stop paying high prices for commodity services.
But the market is not efficient and bankers are creatures of habit, which means that high pay will continue into the future.
So if you’re breaking into investment banking right now, there’s no need to worry: you’ll still make a lot of money.
Even if, on an hourly basis, it’s not much better than McDonald’s.
Break Into Investment Banking
Free Access to Exclusive Content for Members Only!
Sign up for The Banker Blueprint today and enjoy:
- Free Report: 37-page guide with the action plan you need to break into investment banking - how to tell your story, network, craft a winning resume, and dominate your interviews.
- Exclusive emailed bonus material.
- Free Banker Blueprint newsletter with more in-depth advice.
- Unlimited access to all articles, videos, and advice - and free updates whenever new content is added to the site.
great post that provides an explanation to peers on what bankers do. keep it up!
hello, i am a senior student working on a research paper
and i was wondering if this is an accurate site.
if i could recieve an answer as soon as possible, that would be great!
Hilary: That depends on your definition of “accurate.” :) This is a blog and it is all my opinion, based on my own experiences. It is NOT a research paper backed up with tons of facts or anything so I would recommend against citing it in any paper you write. :)
Compensation for careers in finance will likely come down significantly after this latest financial meltdown. The market has adjusted.
True, but compensation levels will remain above those of most other fields. For PE/hedge funds in particular, there’s no way you can compete with 2% management fees on $20B under management if you make money by selling services or even high-end products.
in your example, you said that iBankers make so much because they sell companies for millions to zillions of dollars @ .1% profit.
if a company is sold at, let’s say, $50B so .1% of that is $50M…
how is it split? does the iBanker get that whole $50M? or x% goes to the analysts, associates, vps, mds of the group?
does it benefit only the group that sealed the deal?
how many groups are there in an investment company?
how many people are there in a group? what are their functions/positions?
thanks so much!!
It all goes “to the bank.” The $50M itself is not actually split among the group – at the end of the year, the group’s revenue total is taken into account for bonus calculations but pay is not directly proportional, except at the higher levels.
So even if an Analyst didn’t close any deals, he will still get paid the same as other Analysts… but higher than that, and the difference can be significant. In 2002-2003, some VPs made more than MDs if the MD did not close any deals.
Groups at a bank really varies by bank, but maybe around 10-20 main ones at a large bank? People in a group again really varies by bank and group but at minimum there is 1 set of Analyst-Associate-VP-MD and usually multiple people within each of those categories… so one group might have 20 Analysts, 10 Associates, 5 VPs, and 3 MDs (for example).
Dude, bankers used people money for their own expences, and now they want bailout money to spend even more.Forget about plans, investments.Is plain and simple, they waisted huge sums of money.
I agree there are out there some smart bankers, but most bankers cannot justify their income.I mean just buying a crapy bussiness doesnt mean you get rich.That bussiness must work.I believe that despite the fact that the general population is poor, very poor(they cannot afford a reasonable house,education,car,etc) the dept their local comunity is HUGE.There are a lot of money missing.Who waisted all these money.Well the answer is obvious.The sad part is all these money were spend building golden pools filled with shampain.History is repeating itself.If there is no head, then pitty for the body.All the latest “progress” was just thin air.What can be done?Stop waisting money on stupid things, cause it wont help.Invest more in research and education, and try to live a more honest life.
“Shampain” hahaha idiot
Interesting post, but there is one item on which you are completely incorrect. Anyone can get into investing banking. It is in limited. You can start your own firm. Yes if you want a job at one of the big investment banks, that’s hard to come by, but that holds true in any profession. Stop complaining, if you think this is easy work and easy money start your own company and watch the dollars roll in.
“But once again, we come back to the same problem as above: who will be the first to undercut everyone else?”
I’m an investment banker in Southeast Asia. As one of the largest IHs in the country, we experience many of the other firms trying to undercut fees in order to gain relationships with our preexisting clients. Of course, we don’t want to lose mandates to other firms so we tend to match these undercut fees once the other investment houses dive. So my thoughts are, to answer your question, “whoever isn’t closing as many deals as you are”.
As the investment banking climate in the US is obviously very different than it was back in ’07, do you see the same thing happening there at present? IHs undercutting each other?
You don’t see undercutting as much in developed markets – it’s more in places like SE Asia where the market is fragmented and up-and-coming. Even with the recession, banks don’t do that quite as much in the US because often times only the top 2-3 places will even have access to executive at F500 companies.
if someone enters the investment banking industry (i.e. M&A), is there a statistic as to how much an average investment banker earns over the course of his/her life? I’m not talking about the top performers but an average M&A or Capital Markets Banker? What is his net worth, say at the age of 45?
If someone has a business generating $300k a year after tax, would you suggest that they pursue the family business or do you reckon they could do substantially better as an I-Banker? I know I sound greedy, but I hope you see that when one thinks about life (having you own family, etc) money does come into play.
Thanks!
I don’t know of any statistic like that – my guess is that net worth numbers are far lower than you’d expect. Here are the numbers for top business schools:
http://www.businessweek.com/interactive_reports/mba_pay_the_haul_of_lifetime.html
If you make $300K after-tax, personally I would not get started in i-banking at all – to match that as a banker you’d have to get to the mid-levels (VP) at least and even as an MD you may not make much more after-tax, so it’s not really worth it.
Hi M&I,
Thanks a lot for your response! I got a 2:2 from LSE so I thought if I didnt get into IBD, life could be very difficult but you’ve really reassured me.
I have an acquaintance who works at Nomura (DCM) and he mentioned that associates can make over GBP 150k a year. He mentioned that VP’s make over $1m a year and his MD can make $10m in a decent year. Do you think thats a real exaggeration?
Thanks as always!
Dan
That is an exaggeration – VPs rarely make over $1M and MDs usually make in the low millions. Group heads and higher-level executives might make over $10M. But no way you would get to that level without 20+ or so years of experience.
Thanks M&I,
This leads to yet another question (forgive me for trying your patience). What percentage of associates who enter an organisation actually make it to the MD level? Also, Im assuming you mentioned those finances before tax? Lastly, $1M before tax is still higher than $300k after tax right so (monetarily speaking) wouldnt being a banker make more sense than running a family business?
Very few make it to the MD level, maybe 5% or less. $1M before tax is still more than $300K after tax, but consider the hourly rate: 80-100 hours per week in banking vs. much less in your own business (hopefully anyway). If you’re already making $300K money stops being the most important criterion after a point.
I find this site very interesting, I had a conversation with an ex banker who now works as a successful wealth manager for an independent firm and he told me the reason he left banking was simply the hours and that he has a life. He still earns around £200k and spends alote of time on the golf course and takes regular holidays and still only 33. Do you think it’s worth perhaps working in an Investment bank for a couple of years to build up your network and credibility and then say move to wealth management sector?
It depends what you want and what you define as “enough.” If that’s £200k, then sure. Lots of people reading this site want to make billions of dollars (not realizing that it makes no difference after a point), so hedge funds are better for them.
Hey Brian. This is the first time I leave u message. I have one question about your business. Season 5 episode 8, Ari Gold made Dana Gordon head of the studio. I realized Dana had her times almost all given by Ari (since she was working for him). How the hell does that happen? (Despite the facts that she licked his balls and it was win-win for the Ari VS Amanda game)
Does this actually happen in real life? Why would this work??
And if you’re not Brian but one of the brilliant brains, U got my full attention too. =]
??? I’m not sure I understand your question. What does “Dana had her times almost all given by Ari” mean? She was not working for Ari, she was at a studio and Ari had his own agency. Also this site is about investment banking – I just use Ari Gold as an analogy. But I don’t actually know anything about Hollywood outside of what’s on Entourage.
Even I’m a little bit confused with my question now..I believe I was wondering why does a buy-side character(Dana) helped so many times by a sell-side guy in her career. Do IBkers get to maintain similar relationships in real life?
Yes, because they always show buy-side people new investment opportunities.
Suppose one goes to a top undergraduate school, a top business school, and then goes into investment banking at a top firm until 30-33 years old. It seems reasonable to me that at this point you’d have a good chance to be at the point where making more money won’t affect your quality of life in any real way. At this point, how plausible/easy is it to pull out of the investment banking world, and what are the typical options available to such a person who wants a more enjoyable job with fewer hours but doesn’t want to sacrifice too many hours?
Clarification: “too many hours” = “too much pay.”
http://www.mergersandinquisitions.com/finance-investment-banking-jobs-tradeoffs/ In practice very few leave banking… just like Bud Fox couldn’t get in, make the money, and get out in Wall Street.
Interesting Post! Thanks
Ballpark figure, how many analysts do you think there are in NY?
Maybe around 1,000 at bulge bracket banks, if you include boutiques and other firm types it might rise to a few thousand. The entire securities industry in the US is only around 1 million people, and IBers / analysts are a tiny fraction of that, most others are stock brokers etc.
What would be a typical commission structure for today’s cost of money? X%/YM$…starting at small numbers?
1% for M&A deals under $1B, scaling down to closer to 0.1% at much higher levels i.e. $50B deal. For IPOs fee is 7% for debt deals it’s usually 2-3%.
What is the difference in compensation over a three to five year period for an associate, if one works for a top three BB ibank versus a midmarket ibank, assuming top quantile perfomance.
Not much for BB vs. MM, maybe $50-100K over 3-5 years? Not much each year as a % of total comp. Much bigger diff. at regional boutique vs. BB.
Interesting and the same information I got from other sites.
Well I would like to seek advice on raising capital.
The answer I am not able to find out on the question is being an indian citizen how can I raise capital for IPO/pre-IPO from investment banks,private equity,asset management firms,commercial banks,hedge funds,sophisticated investors etc keeping in view that I am not an accredited investor.
I also found out that according to Regulation D,506 a non-accredited investor can raise as much capital,but not being able to get answer from where to raise capital?
Is there any way I could raise capital by being a non-accredited investor,though on quora when I asked this question I got reply as NO.Please give me advice on this.
As a non-accredited investor, you invest. http://www.investopedia.com/terms/n/nonaccreditedinvestor.asp#axzz1WkqrBly8
I presume you can obtain additional funds from your family and friends.
Thanks for your reply M&I.I understood your point,as being a non-accredited I would invest.Just try to understand my re-framed question.
Let us assume if I had asked this question 6 months ago before Linkedid
IPO.Hence I was interested to invest in Linkedin IPO and suppose I wanted to buy
shares worth $50Milllon.It boils down to this that how would I have raised $50Milllion not being
an accredited investor and from
which areas as I mentioned above.That is my question.
I don’t know your background – whether you have family connections, a family office, institutional investor connections or whether you are an institutional investor yourself or not. If you hv/are either one of the above, I assume you know how to invest in IPOs. If neither, you’d have to raise the 50 mn from your own connections. And then, the best bet to get in an IPO is to open an account with one of the bookrunners of the IPO and invest in the IPO. Sorry other than this, I can’t help much here.
Interesting and the same information I got from other sites.
Well I would like to seek advice on raising capital.
The answer I am not able to find out on the question is being an indian citizen how can I raise capital for IPO/pre-IPO from investment banks,private equity,asset management firms,institutional investor,commercial banks,hedge funds,sophisticated investors etc keeping in view that I am not an accredited investor.
I also found out that according to Regulation D,506 a non-accredited investor can raise as much capital,but not being able to get answer from where to raise capital?
Is there any way I could raise capital by being a non-accredited investor,though on quora when I asked this question I got reply as NO.Please give me advice on this.
.1% = 10% which is $5 Billion, a few zeros will make a big diff and a big splash! :)
Hello, I love doing math and I’m good at it. Im also good at accounting and interested in economics. Is this enough of a reason to go into the career of investment banking?
No, these two sites should address your question
http://www.mergersandinquisitions.com/why-investment-banking/
http://www.mergersandinquisitions.com/why-not-investment-banking/
i have always want do do something in the banking area i have the determination and i had a couple of questions first do the bankers get the money up front or over the year and what degrees do you need also in a year how much do they make can they afford a million dollar house
No they get it after the year. You need to get into a top school to get into IB. You can afford a million dollar house maybe 10 years down the line. But since you are so so interested in money with little passion or interest in IB, I wouldn’t suggest you to apply btw.
Please contact me information on where to go for an intership , currently in gr 12 thinking about a furture and really want to figure out the experinece of this industry!
Great Article. I am reading this from a research POV for my project at work. I am researching the Canadian industry so Im not sure if its much different than US but either way… without getting into too much boring detail, I am trying to construct a clean simplified list of the service/products provided by IB firms and their associated revenue generation. It would be helpful if you can answer the folowing questions
1. I understand that When an IB completes an IPO, they receive a % commission on the deal amount.
a.how much does this % vary based on deal characteristics other than $ amount (such as length of project, amount of people working on it, type of company etc)?
b. if the deal is done by a syndicate of IBs, how does this commission get shared?
c.Would they also get to keep some of the IPO shares for ‘free’ and then sell them and collect a “spread”?
2. For M+A type transactions, do they also receive a commission % or are there advisory type fees based on the time spent? What if a company goes for a broad buy side deal but then does not find a suitable candidate and pulls out, how do the bankers get compensated for their work when no money was exchanged?
3. What does the equity capital markets team do, and how do they generally get compensateD?
4. is it common for companies to turn to IB firms for general financial advice, how do the advisers get compensated for this work?
5. is there any brokerage type activity (ie. simply matching buyers and sellers without taking possession of the securities)
6. What are the most revenue generating activities (generally) for IBs? what proportion of revenue is in these activities?
I realize the answers depend on a lot of factors, but I am just trying to figure out the general business structure of these firms. If you have access to a true IB firm org chart that would be useful as well.
Yana, thank you for your lengthy, in-depth and thoughtful questions. However, please note that this site is only intended for people looking into the industry (not as a way to finish projects at work), and we usually don’t answer lengthy questions like yours, even if the person is asking the questions to break into the industry. If you want to learn more about ECM, check out http://www.mergersandinquisitions.com/equity-capital-markets/
I realize the intention of the site, I actually just started this job and with a minimal finance bg was thrown into an individual project that requires me to know this very complex industry and its fee structures in and out and present it to my bosses.
This is a very informative blog, and I hoped someone would understand the desparation of researching info that is not available on a tight deadline, and help me out. Plus I dont wanna waste bankesr’ valueble work hours on my juvenile questions.
Please reconsider and help me out just with #1?? Ive done a lot of research but the firm sites seem to boast rather than describe what their departments actually do, and there is almost nothing about fee structures other than here.
Thanks for the link.
1. I understand that When an IB completes an IPO, they receive a % commission on the deal amount.
a.how much does this % vary based on deal characteristics other than $ amount (such as length of project, amount of people working on it, type of company etc)?
fees are generally pretty standard though they can change. Doesnt really depend on length, amt of peeps, type of company though. Below article shd address your question
http://www.bloomberg.com/news/2010-08-31/ipo-fees-hit-record-low-in-hong-kong-as-jpmorgan-deutsche-bank-cut-prices.html?dbk
b. if the deal is done by a syndicate of IBs, how does this commission get shared?
the syndicate IBs decides. Usually joint book runners split the fees equally though this split depends
c.Would they also get to keep some of the IPO shares for ‘free’ and then sell them and collect a “spread”?
No not free.
Well… author is not really familiar with financial business… or simply ignorant.
I bet he was never involved into running financial company, bank, or any investment fund (not even a private, closed, for-friends-only fund). Never ran any business, I think. Otherwise he wouldn’t say that there is no expenses to run a bank (or any financial / investment company).
Forget the cost of the office space, disregard salaries and other compensation, ignore the cost of compliance. Consider just one thing: insurance. You can’t really run any legit business of the visible size without it. If you ever ran any business, the word ‘insurance’ will pop up first when you just THINK about offering ANY services to ANYONE. Bank insurance is mandatory. You can’t take any deposits without being FDIC (or similarly) insured. Which means, before you take even dollar from your customers, you have to pre-pay something to insure it. You are not doing anything yet, you are not making anything yet – but you already in the negative territory. More money you take – more money you spend. How do you make money now? You lend. You give all those money away, profit margins will pay for those silly insurance fees, right? Not exactly. First – you can’t give away all the money from the bank, you have to keep certain amount untouched. That kills overall profit margins (for uninititated). Now, ignore all that reasearch to estimate creditworthness of the borrowers. No expenses. Except – you pay insurance! Yes, again. Before it was for the business of accepting money. Now, it is for giving them away.
No expenses, hah?
That’s for a depository institution. Investment banks do not LEND money – they advise on deals, and take a % of the deal size as commission. We’re talking about totally different things. Commercial banking != Investment Banking. There are expenses obviously but pre-bonus margins are way higher in other industries.
Great post mate.
On your comments re banks undercutting fees, we’re starting to see alot of that in Asia, especially China and India where upcoming banks and boutiques are flooding the market.
Do an APAC IPO league table run and you’ll see a lot of Chinese names popping up on the top 10 list. These are investment banking arms backed by huge commercial/consumer banking machines. Try getting on a deal with them, you’ll fully realize the term “smiling assassin”.
In HK/SG, an IPO fee is 2.5% if you’re lucky. The Chinese banks would happily do it for less. (They have an army of relatively low-paid, paper-pushing “bankers”) You’d be lucky to get a 1% fee on Indian deals.. That’s a whole different animal right there.
So yeah.. it’ll be interesting to see how things pan out in the ibanking industry over the next few years.
What is your thought on this?
I agree with you. I can only comment on HK/China deals, not familiar w Indian deals.
In the ECM/DCM world, China is driving global IB revenues on that front because there are still quite a few companies that aren’t public yet, while many large and well-known US/European companies are already public. For instance, the recent Agricultural Bank of China IPO was the largest IPO in the world, even though ABC forced a 30% cut in IPO bank fees and withheld nearly $50m of the pool to pay “incentive” fees that it will allocate based upon how it thinks IBs have performed. This will likely be the upcoming trend given the increasing bargaining power of Chinese companies. http://www.ft.com/intl/cms/s/0/9e6bb830-90ff-11df-b297-00144feab49a,s01=1.html#axzz1eWZ8DXzE
In regards to Chinese banks doing IPOs for less, there’s always the appeal of having a global bookrunner involved in a deal (i.e. a Morgan/Goldman) vs a local bookrunner (i.e. a Citic) because a global bookrunner has access to institutional investors worldwide and has better brand name than local bookrunners, esp if the company is looking to issue on international exchanges. Furthermore, if you have dealt with the various bookrunners, some global bookrunners do offer work of higher quality though whether they act in the company’s best interest or not is another question
The same is happening in Korea. Here, even the global bulge brackets are cutting the fees to win the mandates, driving the market price (i.e. fee) down. I thought this trend was due to the relatively small size of Korean market, yet it is interesting to hear that it’s happening to other parts of Asia as well. I guess somehow the market is more efficient in the East.
how can we study Bank best
Read the info on our sites. Network with people. Read about financial markets.
very interesting site. but that is for real big deals.
What if the deal is smaller, say a 10 million usd acquisition deal. how much % commission can an investment banker charge/make?
I think readers may be able to offer you better insights on this one.
Where can I find info on how much boutique firms charge on M&A deals ranging from $10M-$50M? I’m trying to put together a value proposition for a higher starting salary, and this would be helpful.
Bankers usually charge between 1% and 3% of the value of deal worth less than $500m, while the fee is down to between 0.8% and 1% for deals between $500m and $1bn, and to less than 1% for the biggest transactions, worth more than $1bn. http://www.guardian.co.uk/business/2010/aug/20/mergers-acquisitions-banking-industry
Readers may be able to offer you better suggestions