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Direct investment is also known as a foreign direct investment (FDI). FDI is an investment in a foreign business enterprise with the goal of acquiring a controlling interest in the enterprise. Direct investment provides capital funding in exchange for an equity stake in a company without requiring the purchase of regular shares of stock.
Understanding Direct Investment
The goal of FDI is to gain a large enough equity stake in a company to control it. In some cases, it entails a company in one country establishing its own business operations in another. In other cases, direct investment entails acquiring control of the existing assets of a company that is already operating in a foreign country. A direct investment can involve acquiring a majority or minority interest in a company, but the interest acquired gives the investing party effective control.
Direct investment is distinguished from portfolio investment primarily by the purchase of common or preferred stock shares in a foreign company, as well as the element of control sought.
Control can come from sources other than a capital investment; however, control over assets such as technology is only considered a critical input. In fact, FDI is frequently more than just a monetary transfer of ownership or control but can also include complementary factors such as organizational and management systems or technology.
Individuals can make foreign direct investments, but companies that want to establish a business presence in another country are more likely to do so.
Foreign Direct Investment Examples
In practice, foreign direct investment can take many forms, but it is generally classified as vertical, horizontal, or conglomerate investment.
A vertical direct investment involves the addition of foreign activities to an existing business. An example would be an American automaker establishing dealerships or acquiring a parts supply business in another country.
The most common type of direct investment is horizontal direct investment. In horizontal investments, an existing business in one country establishes the same business operations in another. A fast-food chain based in the United States may open restaurants in China. Green-field entry into a foreign market is another term for horizontal direct investment.
An existing company in one country adds an unrelated business operation in another country for a conglomerate-type direct investment. This is a particularly difficult type of direct investment because it necessitates both the establishment of a new business and its establishment in a foreign country. An insurance company opening a resort park in a foreign country is an example of conglomerate direct investment.