Could Crowdfunding Shape the Future of Energy?

Crowdfunding has become increasingly popular and when Facebook acquired the virtual reality start-up, Oculus VR for $2 billion it raised the profile of crowdfunding as Kickstarter, the crowdfunding platform that aided in Oculus' success. Kickstarter helped them raise $2.4 million. No other project on Kickstarter has sold for that much money and Oculus is proof that crowdfunding has entered the big-time. 

This increasing profile for crowdfunding has the potential to fill the gaps left by major banks especially as they are refusing to lend to community energy firms. The world needs to find $1tn (£590.3bn) a year of clean energy investment if we are to have any chance of avoiding runaway climate change. Last year, just $254bn of finance was found globally – which is 12% less than 2012 and down a fifth on 2011's record $318bn of investment. Europe in particular is seeing a fall-off in finance: in 2013, investment in clean energy slumped by 41% to $58bn. The UK was one of the more positive areas of Europe last year, with investment falling just 8% from 2012's record figure of $14.3bn

The UK will need to tap new sources of finance to be able to move forward with renewable energy and they can't rely on energy providers or banks for finance and to drive change as they are too involved in their large fossil fuel assets. Many countries have used a combination of community energy generation and crowdfunding to achieve finance. In the US, the country's largest solar power provider has predicted that crowdfunding will provide rooftop solar projects with $5bn of investment within five years.

Further support for crowdfunding has been set out in the proposal that theThe Financial Conduct Authority is to move beyond its narrow focus on risk protection and play a much greater role in facilitating a diverse financial sector. Regulation should allow smaller and more innovative crowdfunding and peer-to-peer initiatives to thrive and not restrict them. There also needs to be greater incentives to encourage more people to invest in order to utilise crowdfunding to shape the future of energy.

Why Pay Dividends, Relevant or Irrelevant?

Dividend decisions are to some extent influenced by investing and financing decisions as a company has the choice to not pay dividends and keep wealth in the company or to take wealth out the company and pay dividends. Therefore if the company has nothing attractive to invest in then the extra money should go to the shareholders so they invest when the company needs them too or the money could be kept to finance the business and keep money back in a high interest account so it is there when it is needed.
 

Dividend payments made by UK-quoted companies is normally twice a year and are out of accumulated distributable profits and not out of capital. So companies that have made a loss can pay dividends if they wish but can only be paid out of the previous years realised profits. This is in order to provide protection for creditors by stopping shareholders looking to remove funds from the firm and removing the capital that was originally provided by the shareholders. The determination of what proportion of profits should be paid to shareholders should aim to maximise shareholders wealth and can only do so if the new share price of the company plus the dividend is equal to or higher than the previous year’s share price (Porterfield, 1965).
 

However Modigliani and Miller (1961) argued that dividend policy is irrelevant to share prices and is determined by future earning potential based on the availability of projects with positive NPV’s. Their assumptions that were made for this to be true included no taxes, no transaction costs and investors can borrow and lend at the same interest rates. Given these assumptions dividend policy can become irrelevant and wealth is created by positive NPV projects that will increase share price and therefore increase shareholder wealth. They argued that dividends simply represent a residual payment and after a company has invested in all available positive NPV projects, then any earnings left over should be paid out in dividends and if no surplus the market value of a company should still rise to reflect the future increasing returns. However if using this theory and dividends are paid regularly then does this mean the company are in trouble as they have no wealth creating projects to invest in?
 

Nevertheless the traditional view supported by Linter (1956) and Gordon (1959) suggests that investors prefer dividends over capital gains because of the uncertainty of future gains so would rather have the money now than leave it tied up in uncertain investments. This conflicts with M&M's (1961) theory as if investors prefer dividends then this would influence the market value of the company as a company that pays low dividends to investors may sell their shares in favour of a company that pays larger dividends. This would cause the share price to go down for the company so meeting short term expectation may be better for the company than looking at long term value growth.
 

The importance of dividend payments are also evident to shareholders as they see a high dividend payment as good news and a low one as bad news which in reality could be the opposite causing asymmetric information to be signalled to the market. As investors do see dividends as information (Pettit, 1972) management of the company should communicate effectively if the dividends are reduced in order for it not to be detrimental to the share price and thus shareholder wealth.
 

Clientele effects argues that shareholders are not indifferent to dividends versus capital gains as they need a regular income as some shareholders may require a regular income in order to meet liabilities. M&M believe that this shouldn’t be the case as shareholders can create their own income by selling shares but this doesn’t take into account the implications this has in terms if transaction costs, how time consuming this would be and the tax implications this would incur. M&M ignored tax yet investors are attracted to companies that best suit their needs in terms of tax as dependending on their income tax levels they would prefer either dividends or capital gains.
 

Agency problems also exist within the payment of dividends as shareholders and management are separate individuals with different aims. Firms have been known to pay out high dividends shortly after issuing shares to raise funds for investment and is seen as an indication the dividend shouldn’t have been paid in the first place. It is also inefficient practice as shareholders are taxed on dividends and issuing shares is costly both of which erode shareholder wealth. However this could also be beneficial to the shareholders as if the dividend is higher, then the amount of retained profit available to managers is lower therefore forces managers to justify their investments as they would require funds to be raised eternally.
 

Lloyds bank is an example of a company that rewards its shareholder ‘s with dividends as before the financial crisis they had a record of being one of the highest dividend paying stock in the UK, paying out just over half of its profit in 2005 and 2006. However since the credit crisis hit the bank has not made a pay-out which reflected the crisis that they were in. The pre-tax profits that Lloyds have made this year has strengthened their plan to pay its first dividend since it was rescued, this supports the importance that companies place on paying dividends to shareholders to signal how well the company is doing. Restarting these dividends is seen as a key prerequisite for Britain to sell any of its remaining stakes to retail investors with possibly handing out to shareholders more than half its future earnings
 

Finally, dividends are considered an indicator of a successful company as they are essentially paid out of the previous year’s profits, the director’s view of the coming year and the financial strength/ liquidity of the business. Therefore if companies don’t want to see the market value of their company drop regardless of dividend payments they need to make sure this is communicated effectively and is justified to their shareholders. In reality, most companies aim to provide stable dividends with stable growth and even in time of fluctuating profits they will try to maintain the level of dividends paid as a result of signalling to the market.

Does an Optimal Capital Structure Exist?

Companies can raise capital through debt or equity or a combination of the two each having its different costs with equity a higher risk therefore demand higher returns, and debt a lower risk so lower cost and cheaper. The WACC calculation suggests an optimal capital structure exists and if so then it would be in the company’s best interests to move towards this optimal capital structure in order to increase shareholder wealth. The traditional view is that since debt is cheaper than equity, as lenders require a lower rate of return than ordinary shareholders, debt interest can be offset against pre-tax profits. As dividends are tax deductable and transsaction costs for debt is less than issuing shares then it would seem to suggest that a company should take on more debt. This would increase their gearing level in order for a lower WACC which would reduce the overall cost of finance.
 

However it is not that simple as a higher gearing level coincides with higher risks of financial distress. Too much debt and capital structure influences the business prospects as interest on the debt needs to be paid whether a profit was made that year or not. Furthermore the cost of capital and firms prospects depend on market values and they can fluctuate depending on whether investors believe it to be a success or whether it will fail to achieve the expected cash flows or is a riskier investment that initially thought. Therefore high gearing would benefit the company with a lower WACC, but also brings increased risks to the company’s shareholders which can also end up increasing the WACC through increased cost of equity as shareholders demand more returns as compensation the risk the increased debt holds. This defeats the aim that gearing is to increase shareholder wealth as how the shareholder perceives the high risk from increased debt can destroy value.

 

   IBM is an example of a company that uses a mix of debt and equity to achieve a low WACC:

However if they raise their level of debt and decrease the equity then their WACC is reduced, but this may cause the amount of debt to be a concern to their shareholders 

On the other hand Modigliani and Miller (1958) developed a theory that argued the capital structure of a firm does not have an impact on WACC and the overall value of the firm is constant and shareholder wealth cannot be enhanced by altering the debt to equity ratio therefore no optimal capital structure exists. Their theory however was based on some major assumptions that required the firm to operate in a perfect market of perfect knowledge, that individual shareholders can borrow and lend as cheaply as corporations and in which there is no taxation and financial distress does not exist. These assumptions don’t relate to the real business world so it is hard to believe based on their theory that an optimal structure doesn't exist.

In 1963 Modigliani and Miller revised their previous research to take tax into account; this adjustment dramatically changed their theory as debt has the major benefit of being a tax deductible expense which can be offset against profit. This new theory suggested that the best gearing level for a firm interested in shareholder wealth maximisation is the higher the better, but in practice extreme positions are avoided and companies should borrow to a ‘reasonable’ level however this level can be perceived differently by different businesses. This reasonable level has also changed as market sentiment has come about  in 2007/2008 after the recession, and is assessed based on individual circumstances and now the market has changed shareholders have changed their perception of debt as they have seen how irresponsible lending has damaged the economy and destroyed so many businesses.
 

Miller (1977) also included financial distress in their studies which concluded that WACC goes up at the end therefore relates back to the traditional view but had no conceptual basis for this so proved that an optimal capital structure does exist.

The recent recession as a result from the credit crunch supports the importance of capital structure as it was a result of banks, individual and businesses lending irresponsibly and not being able to repay their debts. Therefore banks are the only industry in the world where the government specifies target leverage ratios and from the recession central banks in 27 countries have took the initiative to  release the Basel III agreement to strengthen the capital requirement for banks further as the current ratio set by the government clearly didn't work. The main requirement for this agreement would mean that banks will have to hold 7% of their assets against their debts, which currently is 2%. However will this be enough to prevent another crisis and slow the growth of the banks, with others suggesting that to bring down bank leverage, all capital regulation should be abolished in order to put shareholder wealth maximisation at the forefront of the business and not in meeting these targets.

Theory has concluded that an optimal capital structure may exist however in practice it is more likely that a range of capital structures exists in which a company can minimise its WACC rather that one particular ratio of debt to equity finance. It would seem that a company that integrates sensible and affordable levels of debt into its capital structure can enjoy the tax advantages, arising from debt finance and as a result reduce its WACC, as long as it doesn't increase its gearing levels to a level that would give a cause of concern to its shareholders.  

Issues in Financing Family Business

It is largely recognised that family businesses can be seen as the backbone of the economy as they help to build and stabilize it when listed companies cause problems. Deloitte recognizes this: ‘here at Deloitte we believe passionately in the importance of the role played by unlisted companies in helping continued recovery of the economy.’ Family businesses can have this impact on the economy as in 2008 they contributed to 31% to GDP in the UK, they are attributable to 10% of overall tax income and create 42% of private sector employment therefore are the key to a sustainable and growing economy.

As family businesses are detrimental to the economy surely they need to continue growing in line with the economy and LME’s however as the majority of family firms don’t want to give equity away how can they grow without finance and capital. This is a concern and a limitation for family businesses and would not impact the economy but also communities through the philanthropic way in which they tend to contribute to the communities they operate in. Not only do they not want to give equity away but capital lenders also tend to refuse to deal with family businesses as they don’t produce any documentation beyond annual accounts, are closed environments on any problems they may be encountering and are protective of family secrets.

 

In addition, agency problems exist within family businesses as the manager is often the head of the family and will serve their own needs rather than those any investors may have therefore will lead to investors not trusting the family business with their wealth and without that wealth it prevents the family firms undertaking activities in order to expand and grow. Alongside their difficulty in obtaining finance, family firms have to deal with more issues than other firms as not only do they have to manage the dynamic of running a business but also the family relationships within the business that may result in conflicts. These conflicts could be from who will be the successor, younger generations may not have the same business or financial goals as the incumbent which could stifle the firm and the different values in individuals may effect financing decision for example cash vs credit.

 

These traits of family firms mean that they have to raise finance by other means; research by Coleman & Carsky (1996) showed that loans from family members and other informal sources of capital are the major sources of financing for small businesses, however more recent research has found that there is no difference between family and non-family businesses in the way they use credit and in fact it is the size, age and profitability of a company that determines how they use credit to finance their company and the fact it is a family business doesn’t limit their use of credit in order to grow.

Therefore it is not that family firms don’t make financing decisions, but it is effected by various factors and as with any organisation it is getting financial planning right that determines how the firm grows. With family firms needing to ensure that this remains stable as they are usually a major part of the communities they are based in, and can’t risk rumors about their financial stability causing them to loose faith as this is normally their USP and without family firms it won’t only be the communities that suffer but the economy on a wider scale. 

Is Crowdfunding the Best Way to Raise Finance for New Businesses?

Crowdfunding in the current business world has been defined by Larralde (2010) as: ‘An open call, essentially through the internet, for the provision of financial resources either in the form of donation or in exchange for some form of reward and/or voting rights in order to support initiatives for specific purposes.’
 

However crowdfuding isn’t a new phenomenon in the way of raising finance and was actually used to fund the pedestal that holds the statue of liberty. People donated money to fund this pedestal with only the promise of their name in a magazine with $102,000 dollars raised with the majority of donations less than a dollar. This shows the power and influence a crowdfunding campaign can have even before the power of the internet.
 

There are several ways to raise finance through crowdfunding with the rewards that backers can receive. The statue of liberty pedestal was raised through civic crowdfunding/ philanthropic donations, but there are also equity based crowfunding and reward based.
 

Crowdfuding has become an increasingly popular way to raise finance for new businesses or ideas as bank finance has become increasingly difficult to obtain since the economic crisis. The majority seeking finance this way use a reward based crowdfunding strategy and do so through websites like kickstarter and indiegogo. This initially sounds like the best option for businesses looking for finance as it is also a form of advertising as their ‘investors’ will promote their projects and are actively involved from the beginning.
 

The most popular websites that are used for crowdfunding differ in the way they allow a project to be funded. The idea is that the new business posts a video showing the idea/ concept they have that they wish to fund and state an amount of finance they need for the project. Indiegogo allow the funds to be released even if the target hasn’t been reached with Kickstarter only allowing the funds to be released when the amount has been reached.  Therefore if I was pledging money to an entrepreneur I would prefer to do so through Kickstarter as their conditions would incentivise them to work hard and try and create more pledges and if the money was falling short, would encourage them to put the money in themselves. This would surely mean they would protect your money more as they have used their own as well and would have the amount of money they would need to successfully complete the project. However as both the website take a percentage of the money raised would it not be more beneficial for an entrepreneur seeking finance to create their own website similar to ‘just giving’ as then the cut would not have to be taken into account for the target and through the variety of social networks and the internet surely the could be just as successful as if they went through the platform of social media as that is the key attribute that these websites use as your are more likely to back something if your friends have.
 

There are also hidden controversies that some entrepreneurs are not aware of as most crowdfunding platforms attempt to exempt themselves from blame if the project fails to deliver or breaks the law in some way eg through breaking a patent. This however is still an unknown area as it is yet to be tested by law. But surely if the project fails to deliver or break the law the project creator should surely take the blame as it would most likely to be from lack of research. In the terms and conditions there is also the condition that they will be viable for sales tax and VAT which generates the question whether many are aware of this or how many to do disclose this which would significantly affect the amount of funding they would receive. However if research is done the project creator could always find ways around this like registering their company in a place that doesn’t pay sales tax eg Delaware (USA).
 

Although it may seem like there are many things to consider when choosing to use crowdfunding as a way to raise finance, the success stories from using this method can’t be ignored with over 18,000 projects successfully funded through Kickstarter and a 200% growth from 2011 to 2012 shows that this way for raising finance is becoming an increasingly more popular especially with game creators. The graphs below show the areas where the most success is generator so a project, especially within dance is extremely likely to be successful.

Crowdfunding, if successful, can create an increase in strategic options compared to those that use more traditional ways of raising finace like bank loans. These options are available as having a significant amount of money generated from crowdfunding allows the company to have a lower WACC through utilising their capital structure.

For the future it is clear that crowdfunding as a way to raise finance will continue to grow and if a project is carefully risk managed  and contingency money is built in and the initial costing and budgeting are done right then more and more projects should be successful. 

Mergers and Acquisitions: Are they a good thing for Shareholders?

The main motives for mergers include synergy, where two firms together are worth more than the value of the firms apart and these bring the added benefits of market power (often the main reason), economies of scale, internalisation of transactions, entry to new markets and industries and tax advantages. Bargaining power is also a reason for a company to merge as a target can be purchased at a price below the present value of the target’s future cash flow when in the hands of new management through the elimination of inefficient and misguided management and through under-valued shares that have been subjected to semi-strong or strong form of stock market inefficiency.

Managerial motives exist including empire building, increased status and power, hubris (expecting that ‘managerial kiss’ will do wonders for the profitability of the target company), survival (quick growth strategy to reduce the chance of being a takeover target) and free cash flow as managers prefer to use free cash flow in acquisitions rather than return it to shareholders.  Or in fact the motive for M&A activity could be from a third party and influenced by advisers or the insistence of customers or suppliers.

A merger may increase productive efficiency through the removal of poor practice and scale economies and creation of new products through larger R&D departments but a merger may also increase market power for the combined company giving it a monopoly position that it may exploit through control over price increases. Therefore there is a need and requirement to control the company size of M&A's through legal restrictions (MMC) and industry regulations (OFWAT, OFTEL). However evidence has suggested that the desire for market share and power is an important motive for M&A activity to enable the company to strengthen the core business within a global context. However, there is little evidence that merger activity raises a firm’s profitability Ravenscraft and Scherer (1987, 1989) or has a positive impact on the bid company’s shareholder wealth as the overall gain created from M&A activity is lesser than the cost associated with it. 

Mergers can often fail to generate value for acquiring shareholders as often the combined strategy is misguided as in AOL’s acquisition of Time Warner which is even quoted as ‘the biggest mistake in corporate history’ (Telegraph, 2010), and that it is was misguided in the first place and with the advice ‘that everyone needs to think about what there function is in the modern world and the value of activity you and your company are doing’ (Telegraph, 2010). In addition failure can also occur as there is often over optimism and failure of integration in management that can badly affect the morale of the workforce.

M&A often occurs in trends and are often linked to the economy, both domestic and world, and the risks that are associated with M&A in economic uncertainty and are also liked to the levels of political risk. Therefore M&A trends are seen to come in “waves.” Martynova and Renneboog (2008) reviewed a century of transactions and identified six major waves of M&A’s: 1890–1903, 1910–1929, 1950–1973, 1981–1989, 1993–2001, and 2003–2007. Their research shows that the end of a wave typically coincides with a crisis or a recession for example, the most recent wave ended with the sub-prime economic recession in 2007. Therefore companies will only carry out M&A activity when the economy is good in the hope that i is successful. 

M&A activity is a huge decision for companies as it affects everyone involved in both of the companies including shareholders, management and other stakeholders. These can include the customer which often relish the economies of scale associated with a merger or acquisition in relation to the price benefits and added variety of products that could occur but could also face price increases if the result is a higher power company that gains a monopoly in the market. There the local government, community and suppliers may also potentially be affected. The employees and managers also need to be taken into consideration when looking at stakeholder and the cost of M&A’s. Fewer employees will be needed so unemployment rates rise and the management and directors of the target company often have to take redundancy packages (often attractive ones) therefore adding to the cost of M&A’s.

However this is not always the case as in the merger between Fyffes and Chiquita to create the world’s top banana company with Fyffes' (the target company) chief executive becoming the CEO of the combined company (Financial Times, 2014) in order to ensure that the interests of both companies are taken into account which is often the fail for a failed merger or acquisition. 

Another merger in the news is the one between Dixons and Carphone Warehouse. They are discussing a £3.5bn merger that could create a powerful new force on the UK high street and a new FTSE 100 retailer. The proposed deal, bringing household names Currys, PC World and Carphone Warehouse under one umbrella, would forge a retail powerhouse with 3,000 stores and sales approaching £12bn. Analysts warned, however, that the alliance could trigger job cuts and some store closures in the UK. This merger is seen as a merger of two equals and could benefit each other in the terms of the much needed re-branding for both companies and allowing it to try and compete online as many sales are moving online and with Apple as they open their own retail shops. The deal is to be made through shares rather than cash so it is yet to be seen which shareholders or stakeholders if any will benefit through this merge.

With all this is mind does M&A benefit the shareholders and increase their value. I don’t think so for the acquiring company but it does tend to for the target company with their share price being subjected to semi-strong/ strong form efficiency and often rising with investors and business executives knowing all too well. In the recent merger proposal of Myer to rival David Jones of $3bn, controversy occurred when the day before the offer was made two David Jones’ directors bought thousands of shares in the company showing that they recognised that shareholder wealth can be generated for the target company but with the high failure rate of M&A taking the risk to do so surely is done with maximising shareholder wealth at the back of managements mind. A recent study by KPMG found that 83% of deals don't end up boosting shareholder returns, so are they worth the risk?

Foreign Direct Investment: Advantages and Disadvantages

FDI is defined as the purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. It can be through Greenfield investment where an organisation invests in buildings or plants in a foreign country to runs its business from. FDI can also be from international mergers and acquisition activity where an organisation runs a subsidiary in a foreign country, which is seen as the preferred option in most cases as the subsidiary will already have established facilities and workforce and a presence in the country.

FDI has largely grown in the past few decades as a result of increased international trade, removal of capital controls, growth of multinational business and their needs of funding, world economy becoming more interdependent and closer financial links between countries as well as greater integration of their financial markets. However Global FDI declined in 2012, mainly due to continued macroeconomic fragility and policy uncertainty for investors and it is forecast to rise only moderately over the next two years, but this global picture is only part of it. For the first time ever developing economies absorbed more FDI than developed countries ($142billion more), with four developing economies ranked among the five largest recipients in the world. Previously they were avoided because of their weak markets and political uncertainty and corruption but in recent years a number of developing regions, such as Asia, attracted high amounts in FDI as a result of having to offer specific beneficial characteristics such as rich natural resources, cheap labour, low corporation tax rates. Furthermore, developing countries also generated almost one third of global FDI outflows, continuing an upward trend that looks set to continue.

Developing countries encourage FDI to obtain overseas resources, increase access to return markets, increase local capital markets and drive economic growth. Developing countries that attract FDI potentially benefit from resource transfer, including capital, technologies, management skills and ‘know how’ as well as increased number of employment spaces. This provides further benefits in the form of tax for that country, its government and society. Additionally, different organisations entering the same country may increase the quality of trading as part of competition, which would also potentially benefit the society.

The growth of FDI has led to a greatly increased role that Transnational Companies (TNC) now play in international production. TNC FDI has increased rapidly in the past decade due to government policy liberalisation, rapid technology changes and increased global competition for new markets. In 2005 they accounted for 10%, 17% and 13% respectively of the estimated foreign assets, sales and employment of all TNC’s worldwide with the top 10 having approximately $1.7 trillion in foreign assets (36% from the top 100) however this has slowed since 2011/12.

FDI flows for 2012 and 2013 were close but as macroeconomic conditions improve and investors regain confidence in the medium term, TNC’s may convert their record levels of cash holdings into new investments. FDI flows could then reach up to $1.8 trillion in 2015. Nevertheless, significant risks exists that could continue to affect FDI levels including structural weaknesses in the global financial system, weaker growth in the EU and significant policy uncertainty in areas crucial for investor confidence.

India is one of the world's fastest growing major economies and needs foreign capital to boost infrastructure and sustain economic growth at its near-double-digit targets. Regulatory uncertainty and bureaucratic hurdles, however, have contributed to a slowdown in inbound investment. However, India has recently become more of a target for companies for FDI especially since the commercialisation of banks and the revised allowance of FDI in additional sectors previously not available for example 100% ownership in the telecoms sectors versus the previous 74%. There have also been talks recently that India is to open its state-run railways for FDI to expand its networks and modernise its operations. A top official was quoted recently that the Indian government was to open 100% FDI in railways and are looking to attain $10billion in FDI over the next five years to improve and expand its infrastructure, spanning suburban corridors, high speed trains and freight corridors. India once had tough investment rules and had to be approved by the government but since they have eased their FDI rules this could boost the FDI India needs. 

However, the benefits for the host country for FDI may not be as beneficial and sustainable as first believed. FDI would be thought to increase capital, technology skills and knowhow to the county but large multinational corporations often have an adverse effect in the country as many local companies that are already apparent cannot compete with these corporations due to the power and brand strength they maintain so local business’ will close and the amount of people losing their job compared to the new ones that are created is greater. 

They can also impact on government decisions due to the economic power these corporations have which could potentially result in the loss of autonomy. There activities could also impact and lead to environmental damage of the local regions, human right implications, corruption, political conflicts and other issues. One of the examples could be BP and its activities in foreign countries (it had the biggest FDI in India with a $7.2billion tie uo with the country’s Reliance Industries) ,where a number of disasters caused damage to local environment and societies, including the oil spill in Mexico.

These corporations also often only invest in foreign subsidiaries to exploit local resources, avoid transportation costs and for cheaper employment rates. So once these resources are used up or a better alternative is found they will move their activities elsewhere leaving a weakened and vulnerable economy behind. 

Therefore for FDI to be seen successful, it needs to benefit both the MNC and the host country where it wishes to operate. 

But why do companies choose FDI and take the cost and risks of it, instead of perhaps exporting domestic production or licensing the right to manufacture its product to an overseas company or even franchise its operations to a foreign company? Most theories discuss (however not necessarily explain) that companies choose FDI for a number of reasons, including seeking new markets, raw materials, product efficiency, knowledge or/and political safety. 

The main reason why many companies choose FDI instead of transporting its goods is because of potentially high transportation costs especially goods that are low in value and high in weight that can be easily produced anywhere for example cement. 

Other reason of why FDI may be preferred, especially over licensing, is the risk associated with selling the ‘know-how’ and potentially loss of competitive advantage. If a company has a high competitive advantage through technology, management, marketing or product itself, giving a license to another company and transferring the knowledge may result in that company creating itself a direct competitor and often losing out to this ‘new’ competitor who exploits the knowledge. 

Finally, companies may choose FDI because of the advantages of a particular location (e.g. oil, cheap labour) so is necessary to combine the overseas resource and the firm’s assets with the advantages of maintaining the ownership of its special assets (e.g. brand, technical knowledge or management ability).