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Aug 02, 2022 Danny Herbert

International expansion through setting up your own foreign entity

Alex Honnold is an American free solo rock climber—he climbs huge rockfaces with no rope. But he doesn’t expect to summit unsupported the first time around. Instead, he studies the wall, first climbing with a rope to understand the rock and meticulously plan his moves. Most people don’t have time for this, so they rely on a good old-fashioned rope for safety.

It’s understandable that you might want to retain control of as much as possible by opening your own legal entity in the target foreign jurisdiction when growing your business. But international expansion without help is a bit like free soloing—fine if you have the time and resources to learn how, but risky if you don’t. There are many employment, payroll, HR, and IP challenges that could lead to a failed attempt, which could waste your time, or worse, lose the support of your investors.

As Forbes put it, international business “expansion is costly, complex, time-consuming, and frankly, scary.”

Can you set up your own foreign entity?

Of course you can. Despite the challenge, whether you try to set up your own foreign entity depends on your in-house expertise, risk tolerance, and the time you have available for administration. Here is a route a company could take.

  1. Set up a business entity or local subsidiary
  2. Find premises—either your own or perhaps a serviced office
  3. Send over a lead team member from HQ
  4. Create local employment contracts, employee handbooks, HR policies, benefit structures, etc.
  5. Recruit new employees—either directly or via local recruitment company(ies)
  6. Manage your own HR function or outsource to a local services provider

There are, of course, several essential issues to consider if you try the ‘do it yourself’ method.

1. Setting up your own entity

To establish a presence overseas, there are two models a company can generally choose from foreign branches or foreign subsidiaries. The two models vary from country to country, so it would be impossible to provide an exhaustive list. Here’s a look at the structures in the UK and Germany.

Branches and subsidiaries in the UK

A branch is not a separate legal entity from the parent company, but an extension of it operating under the laws of another jurisdiction. As part of the parent company proper, liability and tax requirements (like tax treaties between the countries) are its responsibility.

A subsidiary (usually a limited company), is a local entity owned and run by a foreign parent company. It is a distinct legal entity with separate legal liability. It can enter into contracts, and it is subject to local taxes and laws in the same way that any other resident company is.

Branches vs subsidiaries in the UK

 

Branch

Subsidiary

Cost

Generally cheaper 

Generally more expensive

Liquidation

Generally quicker and cheaper

Generally more expensive and a longer process

Tax

Pay tax on UK profits only

Pay tax on worldwide profits

Financial reporting

Files accounts for the foreign company with Companies House and a trading statement for the UK company.

Generally, file accounts on a standalone basis

 

Parent company owns any liability incurred by the UK branch

Generally, parent company is unaffected by UK subsidiary liability

Ownership

Part of the parent company

Owned by the parent company

Incorporation

Registered as an overseas entity

Incorporated in the UK

Ongoing compliance requirements

Must notify Companies House of any changes to the information in the OS IN01 form

Must file annual financial statements and an annual confirmation statement with Companies House and must also file a Corporation tax return with UK HMRC


Which model you choose depends on the parent company’s practical and commercial preferences. Subsidiaries are often seen as the easiest and cheapest way to enter the UK market, but some companies may prefer opening a branch due to regulatory requirements in their sector.

Branches and subsidiaries in Germany

A branch is connected to the parent company and does not own its own assets. There are two types of branches in Germany: the autonomous and dependent branches. An autonomous branch is internally dependent on the parent company but independently able to conduct business in the German city where it is set up. However, a dependent branch cannot act independently from the head office; it is only used for contracting purposes.

A subsidiary is generally a limited liability company (GmbH). It must have its own share capital and accounting system. Also, the subsidiary can conduct business for its parent company.

Branches vs subsidiaries in Germany

 

Branch

Subsidiary

Legal structure

Not a German resident corporation but a local structure

 

A local German company

Independence

Not independent from the parent company; it must conduct the same business activities

Completely independent from the parent company and can carry out different business activities

Ease of Incorporation

There are generally only moderate incorporation requirements.

Investors must pass through every stage of incorporation when opening a German resident company.

Tax

Taxed based on German laws—double taxation agreements can apply

Pays the same tax as a German resident company

 

2. Send across staff from HQ

When starting out in a new country, it seems logical to send your most experienced and trusted employees to jump-start the process. But it’s important to remember that if you do decide to send employees over, you may still have local employer obligations, including workers’ health and safety responsibilities.

And depending on the country you’re launching in, those employees likely will need work visas.

In the UK, for example, there are various visa categories from “business visitor”, providing limited scope of activity for a maximum of six months, to more formal, long-term applications. Fines for failing to follow the requirements of the UK Border Agency are significant.

In Germany, some people, including directors, board members, and business leaders do not have to apply for a visa if they plan on only spending 90 days in the country in a 180-day period. However, for more than 90 days, a long-term work permit is required from the first day of work. These are generally valid for up to four years but must first be approved by the German Federal Employment Agency.

While your company and personnel will almost certainly meet immigration requirements, visa applications can be longwinded and time-consuming processes that can detract from your main goal of global expansion. This route could potentially be a loss for your main team and negatively impact results in your most important market.

3. Recruit top talent from the local market

When the employment landscape is unfamiliar, finding great talent is more challenging. Companies are often forced to search for candidates using ‘cold’ methods such as LinkedIn, or they rely on traditional recruitment agencies. These agencies are often incentivised to fill the space quickly rather than with the best candidate, and the best talent may be reluctant to work for a company with no history in their country.

Advertising on LinkedIn can be useful for candidates searching for a job, but passive candidates—generally the type that expanding global tech companies are seeking—are unlikely to be browsing the platform. And even if the candidate does see the post, it is not as engaging a method as being personally headhunted. In short, with LinkedIn, it is easy to spend much time attracting the wrong candidates.

As overseas companies will not have previous relationships with recruitment agencies, they generally play it safe and engage up to four different providers. The agencies know this, and as there is only a one-in-four chance of receiving the commission, they exert only a quarter of the effort. Also, providing an exhaustive brief to four agencies about the skills, values, and experience you are looking for is time-consuming.

4. Ensure compliance with overseas regulations

Setting up an entity is time-consuming, taking on average between 160–300 hours. But the administrative costs do not stop when the entity has been established. Employers have to file taxes, make social security payments, run payroll, and carry out a slew of other HR functions to be compliant with local laws and regulations in the target market. The challenge is first understanding the regulations and then continuing to keep abreast of changing legislation.

Not complying with local regulations—being unaware is not a get-out-of-jail card—can put an end to expanding in that particular overseas market.

Local employment law is another potentially problematic area. Whatever the target jurisdiction, it will undoubtedly be distinct from US law. In European countries, for example, employment law is more employee-centric than in the USA. One of the main differences between European and US employment law is what is known as “employment at will” in the USA—meaning that the employer is free to terminate a US worker’s employment relationship without notice, for any reason.

There are also differences for holiday allocations, benefits packages, and pension requirements for overseas employees, all of which must be adhered to for compliance, not to mention attracting quality employees.

5. Balance the costs of opening an entity abroad

Opening an entity abroad can be a significant drain of resources.

Direct costs include filing taxes, running payroll, and making the proper deductions from employees' wages.

Indirect costs include the time and money it takes to equip the company to deal with the legal, HR, and finance issues in the overseas territory. As it is unlikely the team has experience with local laws and regulations, there is always the risk of accidental non-compliance and fines.

And there are also huge opportunity costs, including all the necessary research that needs to be undertaken to find out how to fulfil HR functions and compliance issues.

Conclusion

Tech companies in Series A or B funding will, at some stage, seriously consider international expansion: an exciting yet daunting way of scaling the business. There are two main ways of expanding overseas—setting up your own entity or relying on a trusted local partner to take care of foreign employment, HR, and compliance. During the early stages of your expansion, a third-party solution has the benefit of saving you time and money. It allows you to focus on scaling your business, and you can open your own entity at the right time.

 

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Published by Danny Herbert August 2, 2022
Danny Herbert