19 Merchant Banking Advantages and Disadvantages

Merchant banks, or “investment banks” in the United States, are in the business of international finance. They produce business loans for organizations and handle underwriting. Banks in this field are specialists with foreign direct investment, international trade, and the challenges of being a multinational corporation.

Although some merchant banks provide investment banking services, most of them will not provide a regular banking service to the average person. You’re not going to have a checking or savings account approved at your average merchant bank.

Here are some of the advantages and disadvantages to consider when evaluating merchant banking as a potential option.

List of the Advantages of Merchant Banking

1. You will receive corporate counseling.

Merchant banks will usually provide corporate counseling as part of their service package to corporate units. This is done to evaluate the overall financial performance of a company that is seeking to make a splash in an international market. These evaluations can help a company get feedback that is honest and critical to their success, helping to build a better reputation amongst investors and stakeholders. Suggestions, opinions, and even detailed reports may all be part of the counseling process.

2. You will receive honest project feedback.

Merchant banks will work with your company to develop an idea for a project or review the project profile you’ve already created. You’ll be able to determine an estimated cost for the project, look for financing solutions, and begin to create the action steps that are needed to get the project off the ground. Some merchant banks will even provide help in obtaining government consent to get the project started. You’re going to know if the idea you have is viable at the end of this process.

3. You may be able to restructure your capital.

A merchant bank is able to offer relevant advice to companies about mergers and acquisitions in their industry. They will examine the current capital structure of the company and decide what the current extent of capitalization happens to be. Alternative capital structures may be recommended to ensure regulatory and legal compliance in foreign markets. Disinvestment issues may also be examined here to ensure that any proposed project or investment has the best chance for success.

4. You receive portfolio management.

Services are offered by merchant banks to investors and companies which issue securities. Most clients of a merchant bank are institutional investors, looking to create a secure portfolio that will help to build their wealth over time. You’ll receive the necessary services that are required to provide you with an investment mix that fits your needs, considering any tax bracket issues, objects, and the overall return you’re looking to achieve. Merchant banks will also buy and sell securities for their clients. Some even manage off-share funds and mutual funds too.

5. You’ll receive issue management assistance.

Some merchant banks act as a sponsor for bond issues and other forms of financing that a business may require. They coordinate with other brokers and bankers to publicize the issues, decide whether taking it public is the right course of action to take, and work to select underwriters and agreements which create a relationship that is mutually beneficial for everyone. These banks will also advise on the type of debentures that are to be issued, such as being redeemable or non-redeemable, convertible, or if they should be linked with equity.

6. You can receive immediate debt funding through a merchant bank.

Although a merchant bank often focuses on wealth development over time, businesses can also apply for and receive traditional lending products. You can use short-term and long-term loans from the bank to raise the capital required for a specific project. The application process for lending will usually require a business plan that looks at total costs, expected returns, and the overall credit profile of the company to determine final eligibility.

7. You receive lease financing services.

Merchant banks provide companies with finance facilities and provide leasing to their customers. This gives you the ability to have the use and control over certain assets you may require without the need to take full ownership over them. If you determine that owning is better than leasing, then the banks can help you transition your leasing agreement into an ownership one. They’ll also help you develop options for lease renewals for your projects as well.

8. You are able to protect your IP.

When you work with a merchant bank, you’re working with a partner that creates success for themselves by helping you to be successful. That means they are invested in making sure your intellectual property, patents, and other tangible assets are properly protected. Any information you supply during the merchant banking process is kept confidential. Although you must pursue formalities, such as a prospectus, you’ll still have a source of funding that doesn’t compromise the security of what you value.

9. You can have currency exchanges managed for your company.

Merchant banks provide funds by issuing a letter of credit. If you’re looking to expand internationally, then the letter of credit would be received by the sellers as payment for the purchase you are making. Then you’ll walk through the legal issues required to conduct business in the new market. A merchant bank will also help you to manage currency exchanges as funds are transferred out of international markets

List of the Disadvantages of Merchant Banking

1. Your account will be more expensive than a traditional bank account.

Merchant banks tend to charge higher fees for their services compared to traditional banking services and products. You may be required to have a minimum net worth to work with the bank, have a specific portfolio already developed, or have a strong credit profile with a history of project development to qualify for the bank’s services. Although you may receive the initial consultation or evaluation for free, there is no guarantee your company will be accepted.

2. You have size considerations which must be met.

Thanks to the Internet, any startup or SMB has the potential to enter into an international market. Just because you are present somewhere internationally does not mean that you’re going to qualify for the services a merchant bank provides. There are usually size considerations that must be met, which may include revenue minimums, business structure, and more. If you’re structured as a partnership or sole proprietor, you’re less likely to get the chance to work with a merchant bank on a project unless you’re trying to expand the portfolio of the company.

3. You will always have the risk of a mixed chance for success.

Merchant banks might decide to work with you on a financing package, but that is only one step toward eventual success. Assets are often required for the underwriting process, especially when a business is new to an industry, first getting started, or entering into their first international market. Those assets might need to come from the personal assets of the C-Suite to secure some financing. Merchant banks are like all other banks – they like to invest when they know there is a good chance for a return.

4. You’re not going to receive start-up funding.

Most merchant banks are in the business of helping your company scale upward. The focus is usually on international markets, but in the United States, moving into a new state or community may qualify for banking support. What you’re not going to receive is start-up funding. Your business must have an established record of some success to take advantage of the services which are being offered. And, if you are approved and your business is still young, you’ll have strict repayment guidelines and smaller amounts offered for funding.

5. You have no control over your interest rates or returns.

This issue may be the biggest disadvantage of working with a merchant bank. Most will not provide a guaranteed return if you have them managing your investment portfolio. If you take on a lending product to expand the physical assets of your company, then you have little control over the interest rates assigned to the lending product. Your profile is based on the perceived and real risks that the bank feels are present when working with you. If your company is seen as high-risk, even if it turns out to be a low-risk venture, you’re going to pay more for the services received.

6. You may not receive complete funding.

One way that merchant banks help to spread risk levels around is to provide incomplete funding for leases, expansions, and other investment needs. That forces your company to work with multiple merchant banks instead of one. They benefit because each new contributor lowers their overall risk. You’re stuck making multiple payments for multiple products or paying duplicate fees for similar services until your risk profile can be lowered.

7. You may not have access to every potential product.

Traditional banks may be willing to lend money to you when a merchant bank does not. That is because traditional banks tend to offer a variety of products which lowers their overall risk profile internally, which is a practice that not every merchant bank may follow. If you’re thinking about creating CD ladders and other conservative investments, it may be worthwhile to see what your local bank or credit union could offer, even if your business is classified as a large corporation.

8. You will be investigated as part of the funding process.

It may be marketed as a free evaluation, but what a merchant bank is really doing is a detailed investigation of all your business affairs. They will look at your financial structure, evaluate the security of your assets, and even judge your personal sureties. If something is found to be out-of-order during their investigation, it could impact the credit profile of the company. At the very least, the terms and conditions requested of you may be nearly impossible to meet, which means either changing the structure of your business or looking for funding elsewhere.

9. You do not have a guarantee of a renewal or extension.

When funds are made available through merchant banking, they are generally accessible for a short time period only. Receiving an extension of the agreement, or a renewal, may be uncertain – if not impossible. Long-term funding is sometimes available through merchant banking, but most of the projects that are approved are based on a 5-year period or less. The only exception to this rule involves those who use merchant banks for investment purposes instead of funding purposes.

10. You may have added reporting requirements to meet.

A merchant bank will help you make sure that you’re aware of your regulatory requirements. What they will not do is create the reports for you. When you begin working with a merchant bank, there may be a need for added disclosure to any stakeholders that are associated with your business. There are almost always additional costs associated with added reporting and compliance requirements.

These merchant banking advantages and disadvantages help to show the power of investments within a portfolio. Some investments involved tangible assets, while others involve smart decision-making with stocks, bonds, and mutual funds. When you can put together a diverse portfolio for yourself or your company, a merchant bank will help you find ways to grow your assets, so you can reach your overall business goals.