In their truest forms merchant banks and investment banks are different types of financial institutions that perform distinct services from one another. But in practice, the fine line that theoretically separates the functions of these two institutions tend to blur, as the activities often bleed into one another’s territories. To make sense of it all, a breakdown of the true functions of each entity include the following broad responsibilities:
Pure investment banks are chiefly responsible for raising funds for businesses and some governments and municipalities by registering and issuing debt or equity and selling these investments on an open market through initial public offerings (IPOs). Investment banks traditionally underwrite and sell these securities in large blocks. They also facilitate the mergers and acquisitions of companies through share sales and provide research and financial consulting to companies. While investment banks mainly service large companies such as major mutual fund houses, they can also provide consulting services to private investors through their Private Wealth Management and Private Client Services divisions. The research provided typically contains “buy” and “sell” ratings on various stock investments. The activities of investment banks usually vary from one institution to another. And furthermore, small boutique investment banking firms may narrow their focus to a small area of expertise.
Traditional merchant banks primarily perform international financing activities that may include foreign corporate investing, foreign real estate investment, trade finance and the facilitation of international transactions. Specifically speaking, merchant banks may be involved in issuing letters of credit, internationally transferring funds, and consulting on trades and trading technology. Just like investment banks, the precise list of offerings differs depending on the merchant bank in question. Interestingly, the term “merchant bank” was the British term used to describe investment banks.
While both merchant banks and investment banks operate within the financial realm, there are some key overall distinctions. As a general rule, investment banks focus on IPOs and large public and private share offerings. Contrarily, merchant banks tend to operate on small-scale companies by offering creative equity financing, bridge financing, mezzanine financing and a number of highly-delineated corporate credit products. While investment banks tend to focus on larger companies, merchant banks offer their services to companies that are too big for venture capital firms to properly serve but are still too small to make a compelling public share offering on a large exchange. In order to bridge the gap between venture capital and a public offering, larger merchant banks tend to privately place equity with other financial institutions, and in the process, they often take on large portions of ownership in companies they believe exhibit strong balance statements, solid fundamentals and strong growth potential.
While merchants offer trade financing products to their clients, investment banks rarely do so because most investment banking clients have outgrown the need for trade financing and the various credit products linked to it.
For more information, read What is the difference between publicly- and privately-held companies?