Robert P. Mollen, Counsel at Fried, Frank, Harris, Shriver & Jacobson (London) LLP.
UK, European and other non-US business founders in smaller markets frequently find that scaling requires cross-border expansion at a very early stage. You will need to address a whole series of business, cultural, legal, tax and other points in an unfamiliar environment. Scaling is hard anyway http://bit.ly/ScaleupChallenges, but the international dimension adds substantial complexity. US scale-ups may be larger when they first scale internationally, but the issues are the same.
Here are some items that you need to consider.
1. Why are you entering the foreign market, and what does that say about how?
Your reasons for entering a foreign market will significantly affect how you go about it.
For example, if you are a B2C or B2B SaaS business that mainly sells online, your primary need may be simply to provide customer support or to address timely fulfilment. It may be possible to address these needs through agents or, if carefully managed, contractors, without the need for a full-scale launch in the foreign market at this stage.
Alternatively, if you are looking to market actively in the local market, you will have a decision as to when this requires “boots on the ground” as opposed to “flying visits.” You may want to test the market and secure some local clients before incurring the expense of hiring local business development employees. For example, many of the non-US B2B SaaS startups with which I work secured significant US business before they incurred the costs (the largest of which are people costs) of setting up in the US. Additionally, they usually have raised (or made) enough money from sources in their home market to support the cost of that expansion.
Finally, if you are setting up foreign operations with a view to securing venture capital funding as well as customers in the foreign market, you nearly always will need to send a founder to sit near the VC firms from which you are looking to raise. This involves not only a significant cash cost (although participation in an accelerator in the relevant market may give you a cost-effective way to test the market), but also a personal commitment by the founder and substantial management disruption for the home business.
In any case, make sure that you are adequately capitalized for whatever course you are following. Undercapitalization is a primary reason why startups and scale-ups fail, and these risks are magnified when you are venturing into unfamiliar markets where the risk of mistakes is higher.
2. How are you going to address management, control and culture?
Your foreign employees will be new to you. They will not have grown up in your culture. This is not simply a matter of your corporate culture –they are also likely to have a different first language, and different national and business cultures.
These employees will be running around with your brand, and doing things in your name. Your expectations of them are unlikely to match their own perceptions, and you cannot assume that they know what they should do or how they should behave.
Consequently, you need to consider carefully how you will address management and control issues, and how you will acculturate your foreign hires to your organization. This is likely to require that a founder spend a significant amount of time in the new market, and, preferably, that the new employees (at least those that are more senior) also spend a substantial introductory period in your headquarters office. Additionally, there will need to be continuous efforts to wrap these employees into your organization, both through in-person meetings and activities and through use of all of the communications tools available (Skype, Slack, etc.).
3. Who will help you navigate?
Your existing support network has probably played an important role in the development of your startup – your business mentors, investors, professional advisors and others who have helped you to develop your business and avoid mistakes.
Your need for the same kind of support in a foreign market is a multiple of your domestic need. You will face many of the same challenges, but in an environment where many of the things that you take for granted at home will simply be wrong, or unavailable. Consequently, consider how you will build that network. Can your existing network provide it, or introduce you to others who can? Are there other resources that are available to help? Can you benefit from the recommendations of, or introductions by, other companies that have scaled up in that market? Governmental bodies (such as the UK Department for International Trade and Enterprise Ireland, London & Partners and the US Commerce Department’s SelectUSA program) and international chambers of commerce also may provide useful help.
4. Employees and contractors
I’ve previously written about the difficulties of identifying, and hiring, the right people, particularly in a foreign market, and I won’t reprise that discussion. http://bit.ly/RecruitmentMistakes However, when I have seen foreign expansions fail, a root cause has almost always been bad people decisions. Don’t overestimate your ability to attract the right candidates, or to assess their suitability. And don’t assume that this can be cured through use of a randomly-chosen commission-based head-hunter, whose interests may differ from yours.
Attracting the right people in a foreign market to join your scale-up, rather than avail themselves of employment opportunities with local companies or larger companies, is really hard. Your network will play a key role. However, you need to turn your weaknesses into strengths – you must find the candidates who are attracted by the fact that you offer a different experience, based on the nature of your business, your culture, your international focus and the entrepreneurial opportunities associated with a scale-up.
Also keep in mind that employee rights and expectations vary significantly from country to country. Make sure that you understand the obligations that you are undertaking when you hire locally, including contractual rights, statutory termination rights (with redundancy payments that may be measured in years), pension rights, very high social charges, intellectual property rights and other factors. These may make your local hires much more expensive than you expect, both from the beginning and also if you need to terminate them down the road. http://bit.ly/EuropeSurprises Also, make sure that you put the correct compliance procedures in place, addressing required governmental registrations, tax and social charge payments and withholding, workers’ councils (if required), health and safety and other mandatory requirements.
Similarly, don’t assume that your home country contractor agreements and arrangements will work on a cross-border basis. Your home country governing law provisions may be unenforceable, and your contractors may be subject to recharacterization as employees even though you think they are contractors. http://bit.ly/ContractorsvsEmployees Additionally, your contractors may have statutory or other rights under local law that are inconsistent with your expectations.
If you intend to send one or more individuals from your headquarters to establish your foreign operation, they may need visas that permit them to work in that jurisdiction. This can be a time-consuming and arduous process, with possibly the longest lead-time of any aspect of establishing your foreign business. Make sure that you obtain appropriate advice, and address any such issues as early as possible.
6. Structure and tax
You will need expert legal and tax advice on how best to structure your operations in your new market. In many, if not most, cases it will make sense to form a local subsidiary, and you are likely to be have a choice between different entity types. Make sure that you understand the pluses and minuses of the various alternatives, including accounting, public filing, governance, notarization and other requirements that may apply to each entity type.
Tax complexities multiply geometrically when you expand on a cross-border basis, so you will need to find emerging company-friendly tax advisors who have prior experience with the problems that you will face. Your foreign business will need to be set up properly for local tax compliance, including registrations and return preparation. It probably will need to do business with its parent on an arm’s length basis, necessitating appropriate intercompany agreements and transfer pricing. You may to find that your subsidiary is subject to tax complexities with which you are unfamiliar, such as sales tax (or VAT), property taxes (or business rates), and other kinds of taxes that are unrelated to income and profit. While this stuff is not rocket science, it can be complex, and fixing problems after the fact is likely to be materially more expensive than getting things right in the first place.
I’ve discussed employment-related and tax compliance above, but there are broader compliance issues that you will need to address. Your first task is to figure out what they are.
For example, you are highly likely to be subject to anti-bribery legislation, both in your home jurisdiction and the foreign jurisdiction, and this applies to actions by your employees and agents. Practices in some markets, in particular, may make it challenging to comply with these requirements, so you need to be sure that you have appropriate policies and safeguards in place.
Other compliance regimes that are like to apply include data protection and cybersecurity, privacy, export controls and sanctions, and environmental and industry-specific compliance requirements.
8. Intellectual property
You will need to confirm that your key intellectual property assets are properly protected in the jurisdictions that are important to you, including but not limited to those countries in which you are establishing operations. These assets include, in particular: (a) trademarks and, if applicable, patents (both of which should be subject to a broader international review in any case); and (b) trade secrets (through locally enforceable confidentiality and intellectual property assignment provisions). Be particularly careful in addressing employee or contractor rights of authorship (moral rights), which may be non-transferable or subject to restrictions on transfer.
You also will need to consider intellectual property issues from a defensive standpoint, e.g., your risk of an intellectual property claim by a competitor or a “non-practicing entity” (sometimes referred to as “patent trolls.”).
9. Commercial contracts
Your commercial contracts probably have been prepared for your home jurisdiction, with its laws as governing and its courts to have jurisdiction over any disputes. That may or may not be appropriate when you enter into new jurisdictions, depending on: (a) any issues of enforceability (e.g., whether local law in that jurisdiction may override your governing law or jurisdictional provisions); (b) commercial issues (e.g., whether your potential customers in that jurisdiction are willing to contract under your home country laws); (c) the contracting parties (i.e., it may be difficult to provide for your home country law and jurisdiction if the contracting party on your side is your foreign subsidiary rather than your home country parent); and (d) your need to maintain as much uniformity as possible across your suite of contracts.
You may also want to consider whether to provide for arbitration for dispute resolution, particularly if your counterparty will not accept the jurisdiction of the courts that you prefer and if there are issues in relying on the courts in your counterparty’s jurisdiction.
In any case, you’ll need appropriate legal advice.
10. Liability and risk management
A key element of entering into any new jurisdiction is assessing your potential liability exposure. Part of this is understanding what risks may arise, given the litigation and regulatory environments. Part of it is understanding what kinds and levels of insurance are appropriate, and confirming that your company group has insurance that is reasonable in light of your activities and your stage of development. Legal counsel can advise on litigation and regulatory risk; an insurance broker with international experience can advise on the insurance matters.
Insurance brokers don’t charge you for advice – they will receive a commission from the insurer if you take insurance through the broker. If you are not convinced that your parent company’s existing broker has the right international experience, get a second view.
It has become increasingly difficult for a subsidiary of a foreign company to open a bank account in many jurisdictions, due to anti-money-laundering identification requirements and other compliance issues. Leave yourself adequate time to address this, and seek recommendations from peers and advisors as to banks that may make this easier to manage.
12. What will it cost?
Each of the steps above involves cost. It will be important for you to know these costs before you commit to the expansion, or retain a particular advisor. Experienced advisors to emerging companies understand that you operate under budgetary constraints – they should be prepared to provide you with fixed or capped costs for much of this work, which is reasonably standardized. Beware of uncapped hourly billing.
Expanding abroad is risky. Don’t just jump in and assume it will all work out. You can’t eliminate the risks, but you can reduce them through appropriate management.
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This discussion is not intended to provide legal advice, and no legal or business decision should be based on its contents. If you have any questions or comments, feel free to contact [email protected].
You will find a listing of Bob’s weekly startup blogs on US and international expansion and early stage financing here: http://bit.ly/StartupGuidesIndex