DIRECT INVESTMENT

Direct investments are largely restricted to private family-owned companies and star t-up companies that have attracted specialist venture capital or private equity interest. Many small companies have to rely on direct investments for the bulk of their financing. In general, however, direct investments present a number of specific problems to both the providers and users of capital:
Matching. It is difficult for individual investors to find suitable companies or projects to invest in. It is also difficult for these companies to identify individual potential investors. There is also a matching problem between the size of individual’s savings and the financing needs of large companies.
Liquidity. Direct investments are inherently illiquid, due to the absence of a secondary market, and this means that savers cannot readily turn their investment into cash. Par ties needing to raise funds in a hurr y from direct investments would also find it extremely difficult.
Counterparty risk. It is difficult for individual investors to determine the credit-wor thiness or viability of the company or project they are investing in. This makes such investments relatively high risk. This higher risk is reflected by the higher returns demanded by investors and hence higher financing costs for the users.
Costs. Appraisal costs for investors in total will be high if each investor has to carr y out their own analysis. The costs of attracting investments will also be high if each investor has to be persuaded of the merits of the case. It is much cheaper and more effective for a company to raise a relatively large amount in one go than raise relatively small amounts from many investors and have to ser vice each investor individually.
Diversification. It is difficult for individual savers to diversify their risks by finding lots of attractive companies or projects to invest in directly.
There is, however, one common form of direct financing that is easy to overlook. This is the credit that many suppliers provide their customers for ser vices and products that have been delivered and on which payment has not yet been made. Most of this credit is ver y shor t term (30- to 60-day payment terms are common) but in a few specialized industries, the aviation business is a good example, vendor financing can be very long term.