Top Four Reasons Businesses Expand Globally and What You Need to Know
By Nathaniel Richards, Business Development, Radius
International expansion for young and fast-growing companies is a tricky proposition for a variety of reasons. Uncertainty surrounding revenue, profitability and market position can lead to conflicting priorities between management and board members. Furthermore, responsibility for managing rapid growth is rarely evenly distributed within an organization, and certain teams such as HR, finance and legal may be understaffed and overwhelmed by the administrative burdens associated with international expansion.
At Radius I work with many companies looking to expand internationally. They range across different industries and business models, and each has had a unique set of requirements. That said, I’ve found that regardless of company size or profile, an organization generally decides to expand its international footprint for one or more of the four following reasons:
- To expand into a new market
- To provide local support for a large client
- To hire or retain a star employee
- To open a shared service, operations or development center
Those new to international expansion should keep in mind that the associated costs and risks may seem to significantly outweigh the potential short-term benefits, especially if the company’s home revenues are substantial. Generally speaking, however, the rewards of growing an international footprint are realized over time. Let’s take a look at each of these reasons, and some things all businesses should consider before expanding under those circumstances.
Expanding into a New Market
The allure of penetrating new markets overseas is hard to avoid for companies looking to boost revenue. Still, while the benefits can be great, most companies proceed with caution. High-growth companies frequently operate with a “lean startup” mentality, which includes the desire to minimize the organization’s tax and legal presences in the host country until definitive proof exists that the expansion decision was correct. This can be a good strategy, though it can come with significant risks if the company doesn’t comply with local immigration, permanent establishment, employer-classification and other obligations.
The bottom line is that if you want to expand into a new market — which is for many companies a necessity in today’s global economy — you have to perform due diligence to understand your legal obligations in the new jurisdiction so you can develop a strategy that realistically weighs risks and rewards.
Providing Support for a Large Client
Signing a big deal with a highly valued client abroad is an exhilarating experience for a new company. But while flying home, it often dawns on the CFO that the client may demand “boots on the ground” in a brand new country. The new client may want your existing, experienced employees on site, or require permanent, local employees to support them in the host country. While you’ll want to meet your new client’s demands, you need to understand related host-country legal requirements before committing.
Those requirements largely mirror those discussed above, and relate to immigration, permanent establishment, legal-entity structures, corporate and indirect taxes, labor laws and more. Keep in mind, however, that employees providing client services are typically viewed by tax authorities as directly tied to revenue generation, so you will likely have fewer opportunities to minimize your legal footprint than in the above scenario. Again: If you’re planning on hiring locals or sending expats to support that new client, make sure you understand the costs and timelines involved when hiring or sending workers abroad. You may wish to maintain a light footprint, hiring just one or two local contractors in country. But you need to make sure you’re complying with local worker-classification and permanent establishment laws, or risk fines and reputational damage in the future.
Hiring or Retaining a Star Employee
Today’s connected workforce allows for remote employees based virtually anywhere in the world. This pushes companies to consider hiring in locations not previously considered. We commonly see two examples:
- A company or its recruiting firm identifies someone in another country that has industry-specific knowledge or experience that is highly valued and considered critical to the company’s success. For immigration or personal reasons, the new hire must remain in his or her home country.
- A company employs a highly valued foreign national and home-country immigration rules force that employee to relocate back to his or her native country. The company doesn’t want to lose this employee’s institutional knowledge and wants to continue the employment relationship while the employee lives abroad.
Companies in either of these situations may first consider paying the employee as a contractor in the new country, and so avoid the costs of establishing a legal entity and of withholding and remitting income taxes to local authorities. However, while employment laws vary by country, the labor laws of most jurisdictions greatly favor the worker over the employer. If local authorities deem that your hire is a de facto employee rather than a contractor, you’ll be on the hook for back taxes and penalties. Furthermore, even if the employee/contractor works out of a home office, he or she may trigger a permanent establishment under local law.
If you do decide to hire or keep the worker as an employee in the new country, you’ll not only have to establish a locally compliant payroll, you’ll have to comply with all local labor laws. Companies new to global expansion often overlook the “hidden costs” of both mandatory and supplementary employee benefits, such as paid vacation, retirement or car allowances that may not be applicable in your home country but can bring significant additional overhead.
Finally, in this scenario the commitment to the host country generally extends only as long as the employee is working for the company. You should know that de-registering, or winding down a presence in another country can be as expensive and time-consuming as establishing operations.
Opening a Shared Service, Operations or Development Center
Most operational executives are intimately familiar with the business case for building offshore development teams or shared resource centers. And judging by competitive compensation packages for programmers in locations such as Northern California, offshoring is not a passing fad. But while the desire for a lower per-employee cost is compelling, establishing any office abroad comes with its own costs, including those associated with compliance and the administrative burdens associated with managing operations and affiliates from a home-country HQ.
While opening a center overseas does have its challenges, especially during the initial phases, it is relatively straightforward. With expert guidance, determining the optimal legal entity to establish will likely be easy, though it may be more time-consuming and costly than you’d anticipated. And as with all the other scenarios, you’ll need to consider not only all your various tax obligations — such as those related to corporate tax, indirect tax, payroll and social tax — but your employer obligations under local law, including those related to any applicable collective bargaining agreements.
Regardless of the reasons for expanding internationally, all businesses new to the process should firmly grasp that managing international employees will come with unfamiliar challenges. Navigating different cultures and instilling company values across borders are difficult tasks. In addition, the relative lack of visibility into host-country bookkeeping and other compliance-related processes can lead to significant risks.
There are many other factors to consider, including employee benefits and managing stock options across multiple countries with different guidelines and regulations. Keeping up with these obligations and options can take a toll, particularly on small teams in high-growth organizations. No matter what your scenario when expanding internationally, due diligence well in advance will be rewarded.