What is a Direct Investment?

Osmand Vitez

Direct investment allows one company or wealthy individual to place money into another entity for income or tax purposes. Large organizations or corporations are common users of the direct investment process. This process allows for one company to obtain control of other entities, effectively helping the investor company to further its economic footprint. Two common ways to make these types of investments are to purchase a large block of shares or use a contractual agreement that allows the investor company to provide the other with external capital.

The direct investment process often occurs through a dividend reinvestment plan.
The direct investment process often occurs through a dividend reinvestment plan.

Purchasing shares through the direct investment process often occurs through a dividend reinvestment plan or a direct participation plan. The first option allows a company or single large investor to purchase stock in a company and reinvest the dividends or capital gains received from the shares back into the invested company. This requires the use of a brokerage house so the investor can make the initial purchase of shares. After that, the company selling the stocks will simply reinvest the dividends and stock gains on its own.

A disadvantage to this direct investment is that the investing company has no control over its investment. Dividends and stock gain can occur when the invested company’s stock is extremely high. This results in fewer additional shares purchased and a lower overall investment. This plan, therefore, is not beneficial if the invested company’s stock continues to rise, reducing the investor’s ability to capitalize on his investment.

Direct participation plans are not as common in a modern business environment, as these plans were primarily tax shelters. Changes to this investment plan, however, reduce the benefits a company will receive when making a direct investment by becoming a partner in another company’s cash flow and tax benefits. Additionally, these investment plans were more common in the real estate and energy industries. These limitations also restrict benefits received from this investment plan.

Making a large direct investment in a company via any method may result in a company having to adjust its financial reporting system. National accounting standards will dictate how the investing company must report its investment on financial statements. A few basic standards exist, however. For example, investments less than 25 percent ownership will most likely result in the investing company reporting the investment as an equity stake. At between 26 and 50 percent, the company may report the investment as a management stake where the investing company can influence some decision on the other firm. Ownership stakes exceeding 50 percent may result in a parent-subsidiary relationship. This requires the parent company to report the subsidiary’s financial information on a single consolidated financial statement.

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