In yesterday’s post (How To Succeed When Taking Your Company Overseas) I briefly mentioned one of the most common problems companies face when going international: having a foreign entity when you do not really need one (and relatedly, having the wrong type of foreign entity, which I will discuss in a future post). This mistake is really more common and in many respects more damaging than not having a company in-country. I say this for the following reasons:
1. Those who fail to form a company in a foreign country when one is required typically know exactly what they are doing but choose not to follow the law because forming and operating a company according to all legal requirements will be difficult and expensive.
2. There are a whole host of international lawyers and accountants (a minority of them, to be sure) who deliberately encourage forming unnecessary companies either because it is an easy way for them to make good money or simply because they lack the sophistication or experience to understand other options.
3. Setting up and operating a company in almost all foreign countries is expensive and time consuming. That is true even in the business-friendly U.S. for new foreign companies who are trying to determine whether they need a U.S.-based entity and in which of the 50+ U.S. jurisdictions they should establish operations. In foreign countries, even the smallest companies usually need office space, employees, attorneys, accountants, and bookkeepers, and they often need specific licenses and must pay taxes as well. Having multiple companies around the world invariably will increase your legal and accountant costs in your home country as well.
4. Shutting down a company in a foreign country and terminating your employees there is usually difficult and expensive, especially in employee-centric countries. If you have been cutting any corners in the way you do business there, this is when your choices will come back to haunt you. Even if you have been entirely above-board with your in-country business operations, shutting down a company can damage your relations with that country and/or your key people there in a way that can hurt or even destroy your business there after you leave. That has serious implications on the potential value of your business if you are trying to sell those business assets, including your potential lingering liability under your indemnity provisions in your transaction documents.
5. Forming a business entity creates an official record for the entity and its underlying taxpayers. This can mean significant reporting requirements for your foreign company’s parent entity and, depending on that foreign country’s tax laws, some onerous and potentially uncomfortable tax exposure to the individual owners behind those entities.
If you form a company and then have to shut it down, the shutting down part is often worse than the formation part, even if your company is only weeks or months old. Once you are in the system, you are there for the whole painful duration, which sometimes includes being subject to the whims of local bureaucrats and politicians who are not beholden to you.
Many companies focus on entity formations for foreign companies, and they can do it more cheaply than a law firm. But those businesses get paid to form a company for you, not to help you figure out whether a company actually makes sense for what you will be doing in their country or even to provide high level assistance in choosing the right sort of entity to form, if one does make sense. The result of this is that countless companies go through the pain and expense of forming companies in foreign countries that they do not need, then operating a company that never actually needed, and then eventually shutting down a company they never needed in the first place.
The first thing our international lawyers do when retained to form a company overseas is to determine whether it truly makes sense to do so. This usually involves our gathering information from the client regarding what it is seeking to accomplish in the foreign country and then figuring out whether it can accomplish all or nearly all of what it seeks without a company. It is not uncommon for us to suggest that they consider “entering” the foreign country via a distribution relationship, a licensing agreement, or simply by continuing to sell their products or services overseas from their existing location(s).
We have lately been seeing an increase in companies seeking our help in forming a foreign entity because they have been told that is necessary to register their intellectual property in a foreign country. Pretty much every time, we simply tell them that this is not correct and that all they need do is register their IP in that foreign country: no foreign country company required.
You would likely be surprised how often we try to dissuade our clients from a particular course of action, even when that action would help us generate more fees. Doing business in a foreign country is difficult enough without taking additional unnecessary steps.