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Global Expansion

Portfolio Company Pitfalls: Three Common Global Expansion Risks that Delay or Inhibit Venture Capital ROI

By November 5, 2020No Comments
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For venture capital, one of the most effective ways to drive the value of your portfolio companies (portcos) is through international expansion. Doing so compliantly, however, requires extensive due diligence and a strategy to support sustainable growth.

When portcos expand overseas without understanding common liabilities, they risk delayed profits, missed funding opportunities, and costly international litigation that threatens their entire existence.

Ensure their success from day one with a scalable global expansion strategy. By making compliance an integral part of your investment strategy, you protect your portfolio companies from common compliance missteps while growing on a global scale.

Common Global Expansion Risks that Delay or Inhibit Investor ROI

We explore three risks that portcos frequently encounter when entering foreign markets—contractor misclassification, intellectual property theft, and accounting liability—along with one solution that helps minimize risk and maximize ROI.

Risk 1: Legal Liability

When hiring in different countries, companies must comply with international labor laws to avoid significant operational, financial, and legal risks. These labor laws are complicated, specific to the country, and continuously evolving. Instead of turning to in-country experts to ensure up-to-date, compliant hiring practices, many companies try to cut corners. To quickly establish an international workforce, companies often utilize misclassified contractors, and end up facing the consequences. Portfolio companies often assume that the only way to hire quickly is through independent contractors, not realizing they unknowingly risk their entire future.

Misclassification happens in 95% of independent contractor relationships that we see. One misclassified contractor can cost a company up to $350,000 in fines and lead to imprisonment and sanction of company leaders using misclassified contractors. Penalties jeopardize the portfolio company’s wider license to operate in-country.

In addition to regulatory fines, misclassified contractors may bring legal claims against companies. If found to be operating as an employee of the portco as opposed to an independent contractor, individuals can seek back payments into social programs that would have been due. Neglecting to understand the risks, and failing to take steps to fix noncompliance, decreases portfolio companies’ value.

If any of your portfolio companies utilize foreign independent contractors, they need to ensure their workers are classified correctly. The following questions help companies determine whether or not their international workforce is compliant:

  • Does the contractor set their own work schedule?
  • Is the contractor engaged with the portco on a temporary basis?
  • Does the contractor acknowledge that they are self-employed, rather than an employee of the portco?
  • Does the contractor have the freedom to complete projects for other organizations?
  • Has the contractor paid and met deadlines for applicable taxes?

Risk 2: Product Liability

Your portfolio companies’ value comes from its intellectual property (IP). That IP must be protected from anyone who interacts with it, including contractors and employees. While a well-constructed local employment agreement is more straightforward and enforceable internationally, an international contractor agreement is not. Instead, it is difficult to invoke IP protection and non-compete clauses as a foreign company via a contractor agreement.

For example, an independent contractor works as a coder in Russia, China, or India. This contractor develops and has access to proprietary source code, and one day decides to steal that IP. Because the U.S.-based company doesn’t have a legal presence in the international market in question, it is challenging to enforce IP protection clauses. Now, the independent contractor can do what they like with the IP–including start a competing company.

As an investor, you understand both the looseness of these contractor agreements and the messy legality of enforcing them overseas. But more importantly, you know a lack of IP protection negatively impacts valuation and ROI.

Therefore, your portco must have a locally compliant employment agreement signed by everyone with access to the IP. IP protection clauses must clearly state that all work completed by an individual is owned by the portco indefinitely. In addition to establishing ironclad IP protection and non-compete rules, these agreements must establish an effective transfer of ownership for a streamlined buyout process. Employment contracts need to be created by legal, HR, and finance teams who have the local expertise to ensure compliance from the outset.

Without these safeguards, the company’s value–and investor ROI–are at significant risk.

Risk 3: Accounting Liability

Outbound payments are another common hurdle for portfolio companies when hiring international employees. While it’s not illegal or noncompliant to transfer money from a business account to a foreign personal account—if done within regulation—it does create unnecessary accounting complexity. As an investor, you’ll want to see transparent payment processes that you trust and understand.

It may seem trivial to worry about who pays an international employee and how that money is received, but these payments may trigger red flags during accounting and legal diligence that ties into the aforementioned legal liability. While this issue is resolvable, it’s better to avoid the problem altogether by starting on a strong foundation of compliance, rather than try to retroactively resolve the problem once it arises. All too often, these avoidable issues delay or reduce expected ROI on a portco.

Overcoming Obstacles to Maximize ROI

Growth into new markets is an effective way to tap into new revenue streams and drive value and ROI for investors. However, global expansion doesn’t come without challenges and additional risks. Ignoring or overlooking these details put companies’ valuations at risk.

A global Employer of Record service, often referred to as an International PEO (Professional Employer Organization), is one solution that many growing companies turn to in order to minimize risks associated with operating an international workforce. An International PEO handles all administrative tasks of hiring in a new country—including drafting locally compliant employment contracts, onboarding employees, and global payroll processing—so your portfolio companies don’t have to.

Legal, accounting, and product liability are entirely avoidable but require significant in-house resources to effectively avoid fines, legal costs, sanctions, imprisonment, IP theft, lack of investors, and lost ROI. Accelerate cross-border growth and create a streamlined path to exit without any surprises by advising your portfolio companies to partner with an experienced International PEO.