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Chapter 7 Instructor Shan A. Garib, Winter 2013

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Objectives FDI creates a new company by two or more existing companiesOne company gives up a lot of controlCompanies can ALSO invest directly in a foreign market without partnering with a local company

◦ Greenfield – riskiest but avoid entry barriers, retain control and make substantial profits

◦ Acquisitions -

This chapter is about the rationale behind FDI and why it might be risky! M&A’s are discussed and considerations before any choice to enterTypes of JV are discussed and why use them

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Foreign Direct InvestmentInvolves investing in company or building in another countryInvolved acquisition of controlling interest in foreign market

Ways to invest:◦ Construction of facilitates eg Greenfield◦ M&A◦ Investment in JV

Reasons for FDIProhibition or limits of imports produced in other countries but can build a production in that countryProducing goods in target market eliminates import duties and taxes or permitsCan get skilled local labour in target market often cheaper costCan become more competitive

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Foreign Direct InvestmentReasons for FDIInvestment to gain access to closed markets Key issues to consider:

◦ How important is the market?◦ How much and what type must be made to gain access◦ What are the ownership requirements for competing successfully

Investment for IntelligenceMostly high-tech companies

◦ Ask these questions: Where are the new areas of opportunity How is business done? Who should the company get to know? What is the competition doing?

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Foreign Direct InvestmentReasons for FDITaking advantage of lower costsLow cost labour and raw materialsSeek expertise and innovation for competitive advantageKey questions to consider:

◦ How important are factor costs◦ How important is an educated work force◦ Can company get cost advantages through automation?

Investment to enhance competitivenessEg first to develop a marketKey issues to consider:

◦ Will the company be first in the market and get comp advantage?◦ Will entering the market force competitiors to react?◦ Can company capture market share? ◦ Will your actions to enter take profits away from competition◦ Can company get preferred distribution?

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Common Investment VehiclesThe reason toenter will determine Investment vehicles

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Greenfield InvestmentsInvesting in the development of manufacturing facility, office or retail site in foreign marketsOwnership is usually held by parent company as wholly owned subsidies

Reasons for making greenfield Investment◦ Need to construct a specific plant to meet business requirements ◦ Need to avoid environmental liability of an existing plant\◦ Avoid expensive retro-fitting of existing plant◦ Absence of suitable and available partners in a target market◦ Presence of legal impediments

Advantages of Greenfield Investment

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Greenfield InvestmentsAdvantages of Greenfield InvestmentBuilt to meet exact needs and can accommodate latest techCan build corp culture by hiring right ppl and training themHave 100% control over what it doesReduced risk of liabilitiesAdjust strategies easily

Drawbacks of Greenfield InvestmentsStrategy is complex, expensive and riskyA lot to invest in, plant and equip, dist, hiring etc…Accusations of being controlled from abroadTakes time to establish plant and equipment/office, hireHard to leave, lots of commitment

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GreenfieldInvestments

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GreenfieldInvestments

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Mergers and AcquisitionsPurchase assets and majority ownership of another countryTwo businesses are combinedMost successful when two businesses have developed a business relationship- mutual trust and respectWithout this, its is called a hostile takeover60-70% acquisitions fail and 90% lose market shareAcquisition ConsiderationsForeign acquisitions or difficult b/c:Capital

Usually done in cash Accounting practices may vary Hard to get valuation info

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Mergers and AcquisitionsAcquisition ConsiderationsForeign acquisitions or difficult b/c:Time

◦ Slow to set up b/c have to find the right company◦ Locating an acquisition can take 2-5 years

Too long to take advantage of evolving marketLegal Restrictions

Cultural Considerations◦ Understand differences

Company Background◦ Know it through research (history, financial situation, reputation,

competitiveness)Environmental risks

◦ Make sure there are unknown enviro risks or liabilities

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Mergers and AcquisitionsAcquisition ConsiderationsForeign acquisitions or difficult b/c:Fact Checking

◦ Ensure all facts/figures are correctDeveloping a relationship

◦ Develop joint objectives Pricing

◦ Rational for pricing must be understoodTaxation

◦ Tax planning can max value of an acquisition◦ Foreign companies not treated the same, not have tax-free offers

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Mergers and Acquisitions

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Joint VenturesTightly coupled form of SATwo companies make a legal agreement to design. Mfg, manage, market, distributeReasons for JV:Get local expertsAccess new techGet reciprocal accessFulfil a legal requirement for foreing owned corporationsShare skills Forms of JV:Unincorporated – legal partnership only, no separate entity, partners maintain ownership in own assestsIncorporated – creation of separate business, shareholders are partners

◦ -no rights to assets but share profits

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Joint Ventures

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Joint Ventures◦ Difference between unincorporated JV and standard partnership:

Partners in JV put in financial or skill based assets Have separate interests in the assists Operate separate businesses In partnership, businesses of partners are run together with common

goal Partners in an unincorporated VJ share in profits but not liable for

other party lossesDeciding what to chose:Level of risk – with an Incorporate JV a partner is liable for venture company's losses limited to amount of invested in sharesLevel of privacy – b/c unincorporated JV is a private agreement it is protected form public scrutiny

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Joint VenturesDeciding what to chose:Accounting – with UNINC. JV partners can retain separate accountsLegislation – UNINC JV allow flexibility in company legislationFinancing – getting loans is easier with INCORP. JV JV ConsiderationsControl

◦ Majority control advantages avoid decision deadlocks, prevent leaks of proprietary info

◦ Foreign partner might resent partner◦ Hard to find local ppl for venture

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Joint VenturesJV ConsiderationsValuations

◦ Each partner contributes to JV◦ Value assessed at beginning

Autonomy◦ JV be independent of two founding partners, with own staff etc

Flexibility and compromise◦ Common goals make things easy

Continuity◦ Changes in personnel, policies and boards should be

minimizedExit Strategy

◦ Must set terms for separation

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Joint VenturesJV ConsiderationsRecord Keeping

◦ Have a detailed legal agreement ◦ Policies and procedures should cover:

Accounting practices Budgeting approvals Capital investment guidelines and restrictions Sourcing of raw materials Transfer pricing Reinvestment or dividend payout Legal counsel Partners’ liability insurance Roles of BOD

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Joint VenturesJV ConsiderationsRecord Keeping

◦ Have a detailed legal agreement ◦ Policies and procedures should cover:

Health and safety Environmental guidelines HR practices PR Conflict resolutions Confidentiality Non compete Exit provisions eg buy-sell agreements

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Joint VenturesAdvantages of JVTap into partners knowledgeUse pre-existing distribution networksPermit greater flexibility in market entryExtend knowledge of both partnersFoster complimentary skills

Disadvantages of a JVChoice of personnel from partner might follow how important the JV is to the partnerLocal partner often hires local staffReputations are tiedJV carries more legal and financial obligationsExit costs maybe high