What Is Direct Investment?

What Is Direct Investment?

Let me explain what direct investment is—it's more commonly known as foreign direct investment, or FDI. This refers to an investment you make in a foreign business enterprise to acquire a controlling interest in it. You provide capital funding in exchange for an equity interest, but without purchasing regular shares of the company's stock.

Key Takeaways

Direct investment, or foreign direct investment, is all about acquiring a controlling interest in an enterprise. You get capital funding in exchange for an equity interest without buying regular shares of a company's stock. This can involve a company in one country opening its own business operations in another country. It might also mean acquiring control of a business's assets that are already operating in the foreign country. There are three general types of direct investment: vertical, horizontal, or conglomerate investment.

Understanding Direct Investment

The purpose of FDI is to gain an equity interest that's sufficient to control a company. In some cases, it involves a company in one country opening its own business operations in another country. In other instances, direct investment means acquiring control of existing assets of a business already operating in the foreign country. You can gain a majority interest or even a minority interest in a company, as long as the interest acquired gives you effective control.

Direct investment is primarily distinguished from portfolio investment, which is the purchase of common or preferred stock shares of a foreign company, and it's set apart by the element of control that you seek.

Control can come from sources other than an investment of capital; however, control of assets such as technology is considered only a critical input. In fact, FDI is frequently not a simple monetary transfer of ownership or controlling interest but can include complementary factors, such as organizational and management systems or technology.

Foreign direct investments can be made by individuals, but they are more commonly made by companies wishing to establish a business presence in a foreign country.

Examples of Foreign Direct Investment

Foreign direct investment takes many forms in practice, but it's generally classified as either a vertical, horizontal, or conglomerate investment.

For a vertical direct investment, you as the investor add foreign activities to an existing business. An example is an American auto manufacturer that establishes dealerships or acquires a parts supply business in a foreign country.

Horizontal direct investment is perhaps the most common form of direct investment. For horizontal investments, a business already existing in one country establishes the same business operations in a foreign country. A fast-food franchise based in the United States might open restaurant locations in China. Horizontal direct investment is also referred to as green-field entry into a foreign market.

For a conglomerate-type direct investment, an existing company in one country adds an unrelated business operation in a foreign country. This is a particularly challenging form of direct investment since it requires simultaneously establishing a new business and establishing it in a foreign country. An example of conglomerate direct investment might be an insurance firm opening a resort park in a foreign country.