What Is Direct Investment?

Direct investment is more commonly referred to as foreign direct investment (FDI). FDI refers to an investment in a foreign business enterprise designed to acquire a controlling interest in the enterprise. The direct investment provides capital funding in exchange for an equity interest without the purchase of regular shares of a company's stock.

Key Takeaways:

  • Direct investment, or foreign direct investment, is designed to acquire a controlling interest in an enterprise.
  • Direct investment provides capital funding in exchange for an equity interest without the purchase of regular shares of a company's stock.
  • Direct investment may involve a company in one country opening its own business operations in another country.
  • Direct investment can also involve acquiring control of a business's assets 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 sufficient to control a company. In some instances, it involves a company in one country opening its own business operations in another country. In other cases, direct investment involves acquiring control of existing assets of a business already operating in the foreign country. A direct investment can involve gaining a majority interest in a company or a minority interest, but the interest acquired gives the investing party effective control.

Direct investment is primarily distinguished from portfolio investment, the purchase of common or preferred stock shares of a foreign company, and by the element of control that is sought.

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 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 is generally classified as either a vertical, horizontal, or conglomerate investment.

For a vertical direct investment, the investor adds 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.