Businesses now find foreign direct investment accounts for as much revenue as direct exports, but what is foreign direct investment and what does it entail for an exporter?
Offshore investment has an increasing role in generating Australian revenue, found the latest Global Readiness index, conducted by the Export Finance and Insurance Corporation (EFIC). In fact, offshore investment earnings by Australia’s top 100 international companies (by revenue) are on par with exports by Australian-owned entities, according to an analysis by EFIC and The Diplomat, based on figures provided by the Australian Bureau of Statistics.
“There’s no doubt there’s a trend to offshore investment as opposed to just traditional exports,” says Andrew Skinner, head of trade services at HSBC Australia. “It’s a trend that has accelerated in the last two-to-three years and I can’t see it going away.”
Sunil Aranha, head of business development at EFIC, says it’s no surprise that Australian businesses have chosen to expand overseas, capitalising on new markets by setting up physical operations: “The only way they can grow is either by acquiring offices or companies that are existing where they already have the customer database. They can take their intellectual property and service that,” he explains.
Understanding Offshore Investment
Offshore investment, also known as foreign direct investment, is a financial commitment designed to promote a long-term interest in an organisation external to the economy of the investor. There are different types of offshore investments, and most of them don’t involve the Cayman Islands.
Many exporters will be familiar with the type of offshore investment that occurs when expanding Australian operations overseas. This may involve setting up an office in an international location, or even purchasing a factory or farm. Although you invest in your company, it’s also considered an offshore investment because the taxes that you pay in that location go towards local infrastructure, as well as providing local jobs. The profits made, however, are yours and count as Australian revenue.
Other types of offshore investment may include the purchase of a foreign entity, whether that’s buying a stake in another company, entering into public-private partnerships or investing in utilities, such as electricity suppliers. Any stake held in a foreign organisation designed to give the Australian investor a return is an offshore investment.
The difference between exporting and offshore investment is a case of where and when you earn money from the business. With exports, for example commodities, the general idea is that you grow or make it here, then ship it off to its destination and you make money from selling the product. With investments, you commit money to a business that you hope will be productive, thus the returns are likely to come from management fees or dividends, which is a longer-term view.
“The invoicing sale may not be done by the Australian company but by your foreign entity, but you still own it and you still get dividends—you are effectively earning money from that source of revenue,” explains Aranha. “If you don’t get back your earnings, then you take it through management fees. Either way there’s benefit to Australia because you make an investment in a productive thing and the money comes back. It’s far more strategic than if you send something out of Australia and you get paid three months later. If you’re putting up a factory in China, it’ll take you three years but it’s a long term generator of earnings for Australia.”
Benefits of Offshore Investment
Growth is the prime reason companies wish to invest offshore. “Australia is a relatively small market, so once you’ve grown to a certain mass you struggle to grow,” says Skinner. “By investing in some of the growing economies in Asia and some of South America, the benefit is accessing faster growing economies. Some of those markets are riskier so typically you can get higher margins. Access to new markets and high margins are very attractive to investors.”
Exporters often bemoan the strengthening Australian dollar, but when it comes to offshore investment, a strong dollar is a good thing. “The growth of the Aussie dollar helps, it gives you more buying power to make a material investment,” notes Skinner. “It’s a great opportunity to buy if you have a few extra dollars on your balance sheet.”
Diversification is also a reason to consider offshore investment. Skinner believes that the economic downturn of the United States will not affect us as much as it might have in the past because Australia now has interests and investments elsewhere. “We have benefited from the fact that we are so close to Asia and Asia has been growing so well,” he says. “Our diversification and our proximity and our access have softened that blow, so we’re seeing more interest in those non-traditional markets. They’ve become almost traditional markets, particularly the BRIC countries—Brazil, Russia, India and China.”
Potential investors need to examine the reasons why they want to invest offshore. The cost and regulatory barriers are quite significant and Aranha says companies must genuinely want to commit to long-term growth, rather than simply reduce costs. “Very few companies shed jobs in Australia and go overseas just to continue making widgets. That kind of negative approach to business is not going to give you longevity,” he remarks. “It may reduce your initial costs so you can survive for a few years more, but unless you’re doing something spectacular with your product, there will be someone out there doing it even cheaper than you are.”
Offshore Investment Barriers
Investors need money to invest, and therein lies the first barrier. The Global Readiness index showed that 92 percent of survey respondents funded their expansion through retained earnings, so the reality is that offshore investors tend to be medium to large companies with equity to spare.
“Companies don’t have access to finance easily as they would for local business,” explains Aranha. “Let’s take a company that wants to put up a factory in China. They go to an Australian bank; Australian banks tend to rely on your cash flow as well as what you can provide in terms of security and they are not comfortable taking a factory in China as security. In those circumstances, the company goes to China and says ‘we’re putting this factory here, can we have some money?’ and the Chinese bank says ‘we’d love to, but you don’t have a track record with us’.”
He adds that the venture capital industry in Australia has, anecdotally, been quite conservative. “Because of that, companies with great ideas with incredible growth potential end up needing much, much more than any bank can give them. What ends up happening is that they get equity from overseas venture capitalists and that’s sad because Australians don’t tend to benefit.”
Skinner agrees that money is a big part of offshore investment, particularly because it allows a business to survive during the time it takes to reap returns. “There’s usually a long lead time before you’ll be successful, so you need to have some backing to withstand the setting up offshore,” he says.
Investment requires a significant outlay of time because of the due diligence required—mainly research, legal and bureaucratic paperwork—but also because investment is a long-term strategy and investors should be patient, especially in the initial stages.
Other barriers are simply regulatory, and may depend on your individual business, so your investment may need to take a different tack. For example, it is notoriously difficult to set up a retail operation in India, says Skinner, “so you might set up a distribution business and rely on the local partners to hold the physical retail shop”.
Political obstacles tend to be well publicised, particularly when investing in utilities or infrastructure. Many countries, especially those with communist governments, are against foreign companies taking whole ownership of an organisation. “Obviously they don’t want to lose control of key industries. You might not be able to own more than 20 percent [of an organisation], for example. There’s caps,” says Skinner. “Each country has those depending on how open their economy is, so that’s a very significant issue and barrier for many people.”
Where to Begin When Investing Offshore
The construction industry serves as a good model for exporters evolving into offshore investors. Many construction companies supplied their services internationally for a number of projects over several years before opening a permanent office on location. This allowed them to understand the culture and government of the country and acquire a feel for the market before outlaying anything. Thus advanced exporters are in a good position to examine their options in existing markets.
Due diligence should be the first initial cost, says Aranha. “That due diligence should be done by well-known, well established legal or accounting firms. Once you have feasibility done by one of those guys, you’ll find it easier to get money because people are ready to back a plan that has been written by people who have professional indemnity for their advice.”
Following due diligence, educate yourself on any issues particular to the location. This may be intellectual property concerns in Asia for example, says Aranha. Then build a network of trustworthy contacts or partners to develop base before establishing physical operations.
On the whole, an offshore investment strategy should not cut corners, advises Aranha. “If you partnered with the wrong person or if you got the market wrong or you aimed only at cutting costs and not at improving quality, you could end up losing a lot of money. It boils down to the fact that one needs to get their due diligence done, and possibly have experience in that market in some form without having invested in anything in the first instance.”
Offshore Investment Help
Advanced exporters will already have a good idea about whether to invest in their offshore markets, but you may need some help with the actual set up.
Government organisations such as EFIC can assist with finance and risk information, while Austrade can provide education. Also look for government resources at the destination country.
Multinational institutions, particularly financial and legal firms, are great sources of contacts and can help you set up an account or a legal framework for your offshore business.
Trade associations, such as the Australian Institute of Export, can provide investors with contacts and information. Again, there may be an equivalent organisation at your destination.
Offshore Investment Costs
When investing overseas, businesses should expect to incur costs for:
* Travel;
* Completing due diligence;
* Professional services (accountants, lawyers etc);
* Buildings (an office, a factory etc);
* Staff wages/salaries (may include an interpreter);
* Bureaucratic expenses, such as tax and regulatory compliance.
Offshore Investment Seminar Scams
Be aware of scams masquerading as offshore investment seminars. These seminars often request that you pay a fee to attend, with the promoters saying they will introduce you to a network of investment advisers. You can often find this information for free through your financial institution, the government or through trade organisations.
Some of these scams claim you can make 30 percent from your investment per month. The Australian Securities & Investments Commission (ASIC) strongly advises against giving money to any organisation whose claims seem too good to be true.
ASIC says:
* Read our warnings about investment seminars that promise high rates of return;
* Attain advice from licensed advisers only;
* Use reputable, genuinely educational organisations;
* Check asic.gov.au and fido.gov.au for regular updates on scams.
