17 Feb How Do #Investment Bankers Make So Much Money?
The perception is that most investment bankers are just rolling in the dough. In reality, the hay-day of investment banking seems to be lagging somewhere in the past. In fact, recent market trends have put downward pressure on compensation in the industry. It is true, most successful investment bankers make above average salaries, particularly at the boutique investment banks where the only cap is performance and effort. But, investment bankers also navigate a very difficult process, take on a great deal of risk and work in high-stress, high-stakes world. The added difficulty should be, and is, rewarded with compensation.
The Risks in Investment Banking
Investment bankers are deal junkies. Many “live-by-the-deal” and “die-by-the-deal.” Their eat-what-you-kill world is further impacted by macro-market conditions. They are up when the market is up and way down when the market is in the gutter. These and other risks, create an income that is often very cyclical and binary, especially for those that source their own opportunities, which is true among bulge-bracket and boutiques alike. Because these risks are typical of many investment bankers, they are often compensated more for their expert input into a deal.
Investment bankers typically charge front-end engagement (sometimes called retainer) fees as well as back-end fees based on the successful closing of a deal. Most of the compensation (as well as the banker’s motivation) is held in the back-end success fee, and rightfully so. This structure helps to align incentives to push to a successful close. As a result of the larger back-end fees, most bankers continue to charge a very modest engagement to ensure all are properly incentivized and aligned. Both general-market and deal-specific risks contribute to the compensation charged and earned by even the most successful investment bankers in the middle market.
If some of the posts here on the investment banking blog have shown, what we do is not simple or easy, nor can it be completed productively by an ex-real estate agent wishing to move into new opportunities. No, the best deal facilitators have both operational and deal-specific experience within specific markets. Doing a deal is more than just having contextual relationships with potential investors and buyers in a given market. It means the intermediary is also versed in a company’s specific market, knows the general pitfalls of running an auction and knows the solutions to deal-killing difficulties when they inevitably arise (and they almost always do).
In short, investment bankers get paid more to do something that can be extremely difficult and fraught with a great deal of grief and complexity. If it were easy, more people would do it. If more people were able to do it, it would effectively drive down the prices charged by investment bankers across the board.
Charging for Pain
I heard a lecture once from the president of a very successful home development company. He said, in essence, “I always judge and gauge the personality of my client from the initial meeting. I do this so I can price into the process the potentiality of his/her business with me. That is, if I think they are going to be a difficult client, I will charge them a bit more as I know there will be more sweat coming out of me for contracting with them. For instance, I charged one client a small premium for building their home because from the outset I could tell they would be very anal about the details. One day when I was walking through the home with this client and nothing but bare studs exposed, he looked in a closet and found a stud that was not straight and was very vocal about it. While I knew it was placed in the closet for that very reason, I did not argue, but immediately had the stud replaced. I had priced his personality into the project so I was happy to make the amendment.”
I have, nor will I ever, treat a client this way, but the illustration is helpful. As part of the deal complexity, comes the added component of deal emotion. Emotion creates its own monster in both buyers and sellers and oftentimes the intermediary is the one who takes the shots for the high-stakes emotional baggage that can come into a deal. Because almost all deals include more pain, stress and general fatigue, dealmakers are typically compensated accordingly.
Economic Supply and Demand
I’m not suggesting bankers are paid too much, too little or enough. I would argue the capital markets are always working to create the right environment where investment banker supply and investment banking service demand are in equilibrium and the price paid for services matches the compensation of the average investment banker. In reality, the compensation of investment bankers is more a function of supply and demand than any other contributing internal or external factor. Which is why, investment banking salaries ebb and flow like many other industries.