Difference Between Merchant Bank and Private Equity

Edited by Diffzy | Updated on: November 19, 2022

       

Difference Between Merchant Bank and Private Equity Difference Between Merchant Bank and Private Equity

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Introduction

A banking company is responsible for all the transactions that take place all over the world. The idea of the bank was initiated in early, 1397, in Italy. Before that, people and merchants used to exchange goods for goods or rather used to lend grains with a barter system, since there was no money to be exchanged. The early modern banking system started in the 17th and 18th centuries when banknotes were issued for printing.

The banknotes concept was started by the goldsmith who used to store the gold, wherein the people who possessed gold would have to give money for keeping their precious gold safe in the vault. The money lent by people to goldsmiths as a depositor, and promissory notes evolved as banknotes.

Merchant and private banking exists since old times which common people and royalties have taken quite the benefit of. Earlier, the bank included very few features such as loans, deposits, debiting, crediting and some policies. But bank today are not just limited to only aforementioned features a single banking company operates as personal banking, corporate banking, investment banking, private banking, transaction banking and many more sectors. This article will help you differentiate two-sector of the Banking system those are; Merchant banking and Private banking.

Merchant Banking Vs. Private Equity 

Because of how far the financial system has developed, there are many banks from which to choose nowadays. Additionally, there are differences in the offers, deals, and finances they handle. Depending on how we want our money to be managed and used, we can choose the best option out of several possibilities. Of course, because we are the customers, several banks make slightly different offers. There never seems to be enough chaos.

Large banking companies most probably provide merchant and Private Equity services. But today, most banks, even mid-sized banks, provide such options for their clientele. The main difference between the two sectors is that Private Equity services are available for every interested participant in the region whether it be business owner, industrialist, millionaire or common citizen. But the Merchant banking sector provides its services to industrialists, mid-sized companies, real estate investors, and even large corporate clients.

The word itself gives out the definitions for both the banking sectors. The term "private equity" refers to more personally accustomed services rather than a mass-market retail banking system, they are also known for long-term growth plans. The only play is to buy, change, sell. There are many ways one can set their parameters to buy & sell the equity.  

And the term "Merchant" as we all know refers to the trading of commodities. Both banks provide their clientele with an abundance of choices in their services.

Difference between Merchant Banking and Private Equity in Tabular form

Table: Merchant Banking Vs. Private Equity
Parameters
Merchant Banking
Private Equity
Meaning
As the name gives out the merchant are the ones who trade and invest. The merchant bank does the same for their HNWIs and business organization clients.
Similarly, the Private Equity sector refers to investing in equities from which one can have huge profits for further merchandising the business in a different region.
Established
The merchant bank was started as an idea of a merchant who traded grains and cloth, in the 11th century.
The Private Equity sector was established in America by ARDC (American Research and Development Corporation) in the year 1946.
Function
The Merchant bank does not only trade and invest but also underwrite securities, manage a portfolio, and credit syndications, and also help in counselling merger and acquisitions.
In the Private Equity sector, the investment is made by a private equity firm and/or venture capital. Each of them has its set of goals for strategies, targets and preferences to earn profit for the development of the company.
Customers
The customers of the merchant bank are wealthy individuals, business organizations, and even corporate companies whether they be small or large scale.
 
The customers of private equity firms are not the HNWIs but the business organizations, whether they be start-ups, mid-scale or old renowned companies.
Profitability
The merchant banking system helps clients raise funds for their new venture, manage clients' portfolios, and even promote their business activities, loan syndication, and even leasing services.
HNWIs get exempted or lower their taxes by diversifying their portfolio. operation of foreign currency, remittance and concierge services, and even performing bulk transactions for customers' finances and loans.
Loans
The merchant bank helps to syndicate the loan i.e., banks help a client to raise credit from banks and financial institutions.
There is no such thing as loans and credits.
Acceptability of risk
The risk is quite high with merchant banking considering that it could go out of business, stolen identities, and chargebacks are high.
The risk depends on the money involved, type of equity, recent market positions and so on.
Debiting
There are several limits and levels for debiting the amount. The level also determines the risk factor.
There is a specific time limit for returning the investment made by the investors in equity. Hence, the investment should be done with utmost planning.

What is Merchant Banking? 

Merchant banking is quite a summation of private and corporate banking because the clientele of merchant banking is not only wealthy individuals but also business organizations, and it could even be some mid-sized companies. These do not only deal with clients saving and offer some loans but also help in investing, international trading, and also for buying & selling commodities.

The Merchant banks were the first and only modern banks. Merchant banks started in the 11th century as an idea of investment banking. And for people who traded commodities such as cloth. Since the Middle Ages, merchant banking is evolved as it started with trading grains and clothes and today it deals with foreign trading and fundraising for wealthy clients and business organizations.

The name merchant was given by their initial dealings and trading of grains & clothes. Also, their work in the initial days was to facilitate & finance the production and trading of commodities, hence the name 'merchant'. But in the modern days, there are so many restrictions on merchant banking that the scope has become narrow.

Different countries have different functionality for merchant banking in the US the term has taken more of a narrower scope by referring to financial institutions providing capital to the companies in the form of shared ownership instead of loans which can be termed as an "investment bank". And in the UK the term refers to 'accepting and issuing houses.

But that's not all merchant banking does in the modern world, they also take care of underwriting securities, portfolio management, credit syndication, insurance, counsel on mergers & acquisitions and so on.

The most notable merchant banks around the world in past & present are J. P. Morgan, Citi Bank, Hope & Co., Rothschild & Co., Barings Bank, The Deccan Merchants Co., Grindlays Bank. Furthermore, the private, commercial and corporate bank has their merchant banking services for eligible candidates.

What is Private Equity?

The private equity system was first started in America by ARDC in 1946. It was first known as a venture capital firm, and later on, it evolved. They are owned by limited partners (LPs) and general partners (GPs). Both the Limited Partners and the General Partners hold the shares in a classified manner, such as the LP holds 99% of the shares with low liability and the GP holds 1% of the shares with full liability.

The private equity firm serves the business consortium, whether it is a start-up, a mid-sized company, or a well-known company. But rather than investing in start-ups, most private equity firms invest in mature companies. The purpose of the private equity firm is to make an investment in equity and earn profits as required by the company. Parameters such as expansion, new-product launch or development, or restructuring the operations, management, or even ownership of the company are taken into consideration while buying and even exiting the investment years.

They serve the companies by investing in them, whether private or public. Private equity firms are mostly merged with venture capital and hedge funds as alternative investments. There are limitations for HNWIs because investors in the asset class need to devote large funds over years.

The research shows that private equity firms have grown since 2000 as their returns have started to strongly increase. Also, in 2021, the total buyouts of the private equity firm were $1.1 trillion. Private equity tends to be popular when markets are high and interest rates are low.

The most notable private banks all over the world are The Blackstone Group, The Carlyle Group, CVC Capital Partners, Baring Private Equity, TPG Growth Capital, IDFC Privat Equity Fund, and so on.

Main Difference Between Merchant Banking and Private Equity in Points 

  • The first and main difference would be private equity is for business institutions and start-ups and also limited services for HNWIs and UHNWIs, and a Merchant bank is for business organizations, large companies, organisations and government bodies.
  • In private equity, the financial needs of business organizations & individuals are satisfied by giving financial services, fundraising tips, venture capital and international trading. In the case of Merchant banking, the customer is the company the financial need of the company is satisfied through capital restructuring, investment research, and counselling in mergers & acquisitions.
  • Although it may seem that Merchant banking provides the same bank account type as a corporate bank account. The individual gets annual interest for the amount deposited in a private bank account, but no such interest is provided in Merchant banking. When compared to Merchant banks, the number of loans granted by private equity is higher.
  • For private equity, there is a varied time limit for the maturity of equity for a certain amount that can be debited, and commercial banks offer a range of possibilities.
  • The scheme provided by the Private Equity system is of high risk to high profit, but the scheme that is avail to Merchant bank consumers are of high-risk high profit or moderate profit.
  • Every banking sector offers a range of services. The Private Equity system serves its clients with venture capital, offshore trading advice, promote business products, asset allocation, high-end returns, and so on, whereas the merchant banks serve with securities underwriting, merchant real estate, leasing services, international trading, trading finance, capital raising for new ventures, and so on.
  • Along with profits come the risk that is to be bear by the consumer. Because the amount of money involved is huge in Private Equity since all clients are either millionaires or billionaires, the acceptability of risk is highly impactable to clients and even banks. And in the case of Merchant banking, the amount of money is a different matter when there can be risks such as stolen identities, charged banks, and even the bank could go out of business. As a result, the acceptability of risk is high.
  • A merchant bank assists businesses in expanding by advising them on how to raise funds in the international market by issuing shares and debentures. Private equity does not support the policy for expansion of the business; instead, it helps the client grow their money via investing for further development.

Conclusion

The financial sector is one of the most important parts of the global economy – both private and Merchant. The Merchant and Private Equity sectors take the deposit of the consumers and later on lend loans to those in need. Banking also helps create credit, provide financial advice, facilitate trade and even help in the formation of capital. And in the modern world, consumers increasingly need banks for paying bills. And bank earns incredible profit in lending loans also they can incur a significant cost for the firm.

Both Merchant banking and Private Equity fulfil the needs of their respective consumer in the best way possible. Both sectors have advantages and disadvantages, but they are growing at a rapid pace these times. Additionally, customers are given the option of choosing between private and Merchant banking. Furthermore, the consumer should have no difficulty determining which type of bank account - savings, current, fixed deposits, wealth management, high-end returns and so on - is required to meet their needs.

Profits & losses, loans, types of accounts, interest rate, cash management & access and insurance are the most important, and basic things we look at when any consumer chooses their choice bank. Understanding the difference between each and choosing the best that satisfies your need is crucial. And due to growth, the technology most banks are operating online which makes it even more convenient and easier on both ends – consumers and bankers.

 References

  • What is the difference between a merchant bank and a private equity firm? - Quora
  • Merchant Bank - Meaning, Functions, Services, Examples (wallstreetmojo.com)

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"Difference Between Merchant Bank and Private Equity." Diffzy.com, 2022. Sun. 27 Nov. 2022. <https://www.diffzy.com/article/difference-between-merchant-bank-and-private-equity-1109>.



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