Although companies are usually highly energized when they plan to expand overseas, they often make crucial mistakes because they’re unaware of the pitfalls awaiting them in various countries. Large corporations growing an existing global footprint as well as smaller startups contemplating their first foreign presence must be aware of a variety of regulatory, political and other forces that can make or break them as they expand to new countries.
Dr. Shan Nair, founder of Nair & Co., which has assisted more than 1,500 companies to expand into more than 50 countries, says companies are going abroad at a much earlier stage in their life now compared to even five years ago. Is there an optimal time to expand overseas or a time when it’s too early? Nair advises companies not to expand unless they can ensure they have budgeted for the “deminimis costs” (salary, overhead and support costs) and unless they have a reasonable expectation of getting the return on the investment. “A key issue is that they’ll be spending money before they can earn money,” he says.
Nair points out that the biggest risks are also the most common mistakes companies make when expanding, and most are tied to local regulations and laws. Although the details vary by region, these pitfalls can be very costly.
Contractor relationships in Europe are significantly different than those in the United States. “Many companies just send the European contractors a U.S. contractor agreement, which is constructed per laws of a particular U.S. state. They think that they’re covered legally. Unfortunately, they’re not,” says Nair.
He explains that the nature of the relationships developed over time between a contractor and an employer – rather than the language in the contractor agreement – drives the European definition of “contractor.” If the contractor, for example, has only one customer, which is a U.S. company, and the contractor doesn’t provide any tools of trade and basically operates under the direction and guidance of the U.S. company, he will likely fail the test for self-employment in Europe and would be deemed an employee.
Further, in many European countries, if the deemed employee works for the U.S. company for more than a year, he acquires additional employment rights that could override anything the contractor agreement might stipulate.
Troubles then ensue if the company gives notice to the contractor that the relationship is terminated according to the requirements of the contractor agreement rather than the local employment laws.
If the contractor is not successful and the company fires him, he has deemed employment rights. On the other hand, if the contractor is a salesperson with whom the company wants to terminate the relationship, some European countries require the employer to buy out the business that the contractor generated for the company. “The thinking is that he has been the U.S. company’s agent; he has built up his own business on the back of the U.S. company’s business, and now the U.S. company is destroying the business he built up,” explains Nair. He cites an example where a successful salesperson in this scenario hit a U.S. company with a $1.5 million buyout claim – and won in court.
“The company can’t win either way,” states Nair. “The salesperson can say, ‘Yes, I was a contractor, but I was a very successful sales agent, and I generated all these sales. Buy me out.’ Or if he wasn’t that successful, he can say, ‘I was a deemed employee, and I’ve been around for more than a year; so I’m suing you in an employment court.”
It’s fine to use contractors in some Asian countries such as Hong Kong and Singapore, but not in Europe or in some Latin American countries. In Brazil, it’s actually illegal to employ a person in their personal capacity as a contractor. In Argentina and Chile it’s not illegal, but the company runs the risk of “deemed employee” as in Europe.
Nair points out that this common mistake around hiring contractors is due primarily to operating on a shoestring while expanding. Companies hope to generate sales in the new country, but they don’t want to spend money until they make money; so they think that the contractor route is the easiest.
Dr. Nair’s recommendation: It’s much safer to acknowledge that the contractor is an employee and use a short-term employment agreement. Once that term is over, the company is no longer bound, although it will need to take some precautionary steps in some countries as the contract comes to an end.
The employment offer letter
Sending a foreign employee a U.S. offer letter that says the individual is employed at will is another big mistake, as there is no concept of at-will outside the United States. “If you send a potential employee in another country a U.S.-style offer letter and employment agreement, you’re straightaway in a sticky wicket because it’s an illegal letter. If you end up in court later, you’re starting off from a negative position because of the illegal offer letter,” says Nair. An offer letter must comply with the employment laws of the country where the employee works.
Another important detail: The offer letter must quote the salary in local currency rather than U.S. dollars because the exchange rate fluctuates and the salary expressed in local currency cannot be reduced from one month to the next without the employee’s agreement.
U.S. ex-pat employees
Even sending a U.S. employee as an ex-pat to another country is risky for those not aware of the pitfall. If the employee will spend more than half a year employed abroad (183+ days), he will likely be taxed in the overseas country, and that country’s employment laws will prevail. So it’s best to start with an employment agreement based on that country’s regulations.
Customer support and VAT implications
Often companies set up their initial operations abroad with a small headcount, typically employing mostly salespeople at first. Later when that entity then starts to provide customer support, which is charged to the customer, a value-added tax (VAT) will apply to the revenue generated from the customer.
As Nair points out, it looks like a small change operationally, but it has big implications because the company can invoice for those services only from a VAT-registered entity.
“This means that you have to go back to your contract of sale and change it so that your VATable services are separated out from your non-VATable services. And you will also have to change the inter-company agreement that exists between the U.S. parent and the local subsidiary, which defines the services that the subsidiary provides,” says Nair.
How big is the risk of not invoicing from a VAT-registered entity? If a customer is inspected for VAT compliance and VAT wasn’t charged on the invoice to the customer, the country’s local VAT authority will require you to pay up.. The exposure could be a large sum to pay all of a sudden.
Indian companies expanding
As India switches from a services environment to software products, a lot of medium-sized Indian companies are expanding abroad. They have a particular risk, Nair says, because a lot of key decision makers in these companies are less experienced since the Indian economy has not been open to international competition as long as European and U.S. economies.
“People who have less experience tend to want to cut corners,” says Nair. “This may suit a company in the short term; but in the long term, it will create risks and downsides. They really don’t end up saving any money by cutting corners. The money they save, they end up paying in interest and penalties when compliance investigations start a few years later.”
Expanding to BRIC countries
A lot of U.S. companies are going to BRIC countries (Brazil, Russia, India and China) to sell products and services since their economies are expanding. The rules and regulations covering selling in those countries are unique beyond the activities of setting up offices, hiring people, paying taxes, etc. There are a lot of do’s and don’ts that require expert advice.
For example, there are certain types of activities that a foreign company cannot conduct in China or India without a local partner in a joint venture. Further, there are certain sectors that are closed to foreign competition. In India, there is a lot of opportunity today to sell to government entities; however, special rules apply, and the required paperwork to clear goods through customs for example is different.
Nair explains that the main concern in Russia is corruption, and there is a set of laws regarding bribery. “U.S. and U.K. companies need to have procedures in place to ensure that there aren’t any kickbacks going on, that the staff is fully trained in the company’s policy on corruption, and that the company has an open culture that encourages whistleblowing,” warns Nair. “There needs to be a very clear-cut anti-corruption policy in the employee handbook before going into BRIC countries.”
Announcing expansion plans
There is also a pitfall in deciding when to announce to employees that a company plans to expand into another country. Nair’s advice is to make the announcement only after hiring the general manager or managing director.
“Success or failure in a foreign country depends very much on the person who heads that operation, both in terms of that person’s intrinsic management and entrepreneurial skills as well as how that person culturally fits into the business and interacts with personnel in the business,” says Nair.
He adds, “If a company announces it’s going into another country and then can’t find the right person to head that operation, it will look foolish in front of the workforce.” This is especially true in companies where the employees have a pessimistic outlook and employees tend to interpret management communications from a worst-case scenario rather than seeing the opportunity or best-case scenario.
Nair sums up his advice to startups and well-established companies moving into other countries with three warnings:
- Get expert advice and be fully aware of the risks.
- Be realistic about the costs involved and make sure you have an adequate budget so you do it right the first time.
- Don’t cut corners.
By training, Dr. Shan Nair is a nuclear scientist. He was instrumental in developing a code that set the then UK standard for calculating waste arising from spent nuclear fuel and was one of two U.K. experts assisting the European Commission in the post-accident Chernobyl response. He then became an accountant. In 1994, Dr. Nair saw promising U.S. companies in Silicon Valley and elsewhere struggling to set up shop in foreign countries. He helped his first client with employment contracts and an infrastructure for payroll, banking, etc. in multiple countries. The 11 people at that company went on to other organizations and hired Dr. Nair to help manage their international growth. Thus the course was charted for Nair & Co., established 18 years ago to help companies in overseas expansion. This includes the set-up of the company, HR, finance, tax and legal issues, risk protection, compliance and more.