More commonly referred to as a “Foreign Direct Investment”, or “FDI”, a direct investment occurs when an investor places money into a company in another country. Many investors like to make this type of investment because it gives them a strong voice in the management of the company. Of course, there’s lots more to learn about direct investing too, so let’s get to it.
How do FDIs come to be?
There are three different types of Foreign Direct Investments; horizontal, vertical, and conglomerate.
Horizontal direct investments are also sometimes referred to as ‘organic investments’. These types of investments occur when an investor takes an existing company and expands it into a foreign country.
Let’s take Tim Hortons for example. Every Canadian loves Tim Hortons, but it’s not so popular around the world. But now let’s say an investor saw huge potential and wanted to open Tim Hortons in China. If they were to do so, that would be a horizontal investment.
Vertical investments occur when a company in one country opens a connecting business in a foreign country. For the sake of keeping things simple, let’s use Tim Hortons as an example again. Tim Hortons uses coffee cups – lots of them. But they need someone to make those coffee cups for them. If an investor were to open a manufacturing plant for coffee cups in China, that would be a form of a vertical investment.
Finally, we have conglomerate direct investments. These are investments that have no relation to a business in Canada. In other words, they occur when an investor invests in a business in a foreign country that has no relation to an existing business here in our country. In most cases, the investor has no previous experience in the industry and uses the investment as an opportunity to learn more about a specific industry.
Why are Direct Investments so Popular?
Direct Investments can be a great option for investors because they can establish a lasting interest wherein the investor obtains at least 10% of voting power within the corporation.
Rather than just investing in something and seeing how it plays out, direct investments allow an investor to have control within the company. When a direct investment is made, the investor is able to play an active role in the management of the firm, and have an influence on its day-to-day operations.
What are the benefits associated with Direct Investments?
There are many different benefits that are associated with Direct Investments:
- Knowledge and skill
When you make a direct investment, you have control over what goes on within the company. Once you take partial ownership, you can begin to gain the skills and knowledge associated with the industry, and also learn about all of the technology involved.
- Greater access to knowledge and technology
Just as investors can gain knowledge and skill by investing in a foreign company, so can the members within the community. When companies expand into foreign countries, that country gains access to new resources and technologies that may not have been there before. This allows community members to gain new knowledge and skill and helps to progress the economy within that community.
- Economic Development
By investing in a foreign company, you directly play a role in stimulating their economic development. Depending on which type of direct investment you make, you can have a drastic impact on the country, as well as the community and community members within which you invest.
- Increased opportunity
When companies are opened in foreign countries, this opens up more opportunities for employment within that country. As companies continue to open and expand, so does the potential of new jobs and opportunities for growth. This not only has an impact on individuals within the community but also within the overall economy.
- Tax Benefits
Direct investments come with a variety of tax benefits and write-offs, regardless of which sector you decide to invest in. Tax benefits alone aren’t a great reason to invest, but they are a great side-benefit associated with foreign investments.
- Lower Labor Costs
A lot of companies choose to expand their business in foreign countries to reduce their labor costs. Labor costs in Canada are very high in comparison with some other countries, so there’s no doubt that moving productions to a foreign country can help to reduce those costs. Of course, this results in greater revenue for the company at hand.
Are there any disadvantages associated with Direct Investments?
Like anything else in this world, there are some disadvantages associated with direct investments. The main disadvantage is the displacement of businesses within the foreign country wherein the new business is established. When new, large corporations move into a foreign city or community, smaller businesses within those cities and communities risk losing business and shutting down.
Walmart, for example, is a huge company in Canada that faces a great deal of criticism. Because Walmart has such low prices, smaller businesses have a difficult time competing. Instead of shopping locally, people flock to Walmart to get the best deal. This causes small businesses to lose money, and in some situations, could cause them to close their doors.
Direct Foreign Investments vs. Foreign Portfolio Investments
A lot of people confuse Direct Foreign Investments with Foreign Portfolio Investments, but it’s important to distinguish that there is a difference. We’ve already learned what a Direct Investment is, so let’s talk about Foreign Portfolio Investments.
A Foreign Portfolio investment is an investment in another country through the purchase of securities and financial assets like stocks, bonds, and mutual funds. Foreign Portfolio Investments can also come in the form of depositary receipts and exchange-traded funds.
The main difference between Direct Investments and Foreign Portfolio Investments is the duration. Foreign Portfolio investments are seen as short-term investments. They are bought and sold off quickly and are designed to make a quick buck.
Direct Investments, on the other hand, are considered longer-term investments. When you invest in a Direct Investment, you are investing in the economy of a foreign country, and have the opportunity to have a voice within a company. Foreign Portfolio Investments do not provide the same opportunities in this sense.
How Can I Get Started in Direct Foreign Investments?
The best way to get started in Direct Investing is to speak to a financial advisor at your financial institution. Most large banks in Canada can help you to get started with Direct Foreign Investments.
Some banks, like TD for example, will even allow you to set up your account completely online. TD Bank provides its customers with the education, tools, and platforms to learn more about, and get started with, direct foreign investments. Each bank will offer its own benefits and advantages, so be sure to compare financial institutions before creating your account.
In conclusion, Direct Investing is an investment opportunity that allows you to play a role in the economy of another country. It also gives you the opportunity to learn, grow, and have a voice in the everyday management of a growing company.
With that being said, direct investments are considered long-term investments and will not make you “quick cash”. Still, if direct investing is something you are interested in, speak to your financial advisor today to see how you can get started.