Establishing a legal entity is a traditional route for businesses building an overseas presence. While this method ensures compliance with local laws and regulations, it is an expensive and time-consuming process that puts a significant strain on internal legal, HR, and financial resources.
Businesses must budget thousands of dollars to get a legal entity up and running in most overseas markets. However, the total costs of establishing an entity go far beyond the initial setup phase.
Along with the initial capital investment on entity setup, the average direct and indirect ongoing entity maintenance fees average hundreds of thousands of dollars annually. This number changes drastically depending on your selected market, the number of employees hired, their required salaries and benefits, and additional factors.
Creating and maintaining a legal entity requires a long-term financial commitment. If an organization selects this global expansion route, it must have a large budget in place.
Businesses need knowledgeable internal teams with adequate bandwidth to keep up with changing laws and regulations within a global marketplace before undergoing an entity setup in your chosen location.
Before a business decides to establish a foreign entity, here are four hidden costs to consider throughout the initial startup phase—and while running an overseas entity:
1. Registered office address
Most countries require a physical registered office address to establish an entity and receive a tax ID. Depending on exchange rates, market demand, and the size of space a business needs, average real estate or office space prices in a target market might be more expensive compared to the firm’s HQ location.
In addition to purchasing space, companies need to provide technology such as phones, computers, software, and other materials employees require to run their overseas operations successfully, which is an added expense.
2. Resident director requirement
Another requirement to establish an entity and receive a tax ID is hiring a resident director. This resident director is any local employee who acts as a legal representative for a company. This person signs paperwork for a business in the new market and goes to court in the event of any legal issues.
Companies must factor in the salary for this person or the fees for hiring a third-party company to act as the resident director.
3. Ongoing administrative costs
It typically takes over 100 hours to research and complete the necessary tasks for entity setup—but that is just the beginning of the required time investment. There are both direct and indirect administrative costs that companies are responsible for throughout the lifetime of their entity.
Direct costs include everything legally required to keep an entity compliant in the foreign market, such as;
- Yearly tax filings
- Monthly social security payments
- Running payroll
- Other necessary payments that are specific to that market
Indirect costs include the time and resources required to train internal legal, HR, finance, and operations teams to manage their tasks in a new country compliantly. Many companies have little to no experience with the local laws and regulations in their target market. Educating internal teams and keeping them up-to-date with changing legislation is an additional cost that firms must consider.
4. Entity teardown fees
If a business chooses to leave a country where they have a legal entity, it must go through a lengthy process to officially tear it down. Dissolving an entity typically takes 3 times longer and costs 3 times more than the amount required to establish the entity.
This process is complex, and the dissolution costs and time commitments vary drastically from country to country. However, many costs come from completing necessary closing responsibilities, such as end-of-year compliance tasks, paying annual taxes, fulfilling severance requirements for employees, and much more.
In general, it is more expensive and time-consuming for companies in heavily regulated industries (such as banking), have higher annual revenues, and have a significant headcount to dissolve an entity.
5. Opportunity costs
Foreign entity setup is time-consuming, and time lost in this extensive process leads to missed revenue opportunities. On average, it takes up to 4 months or more to establish an entity and begin operating in a new country. Companies must consider what they could lose during this time, such as revenue, or competition gaining traction in a market, taking away valuable customers.
Since entity establishment is a long, complicated, and expensive process, a natural question arises: How do I know if my company must establish an entity overseas or if I can seek other global expansion options?
Here are three reasons why businesses may decide that entity establishment is a viable option for them:
1. They must hold fixed assets
If a firm is in the real estate or manufacturing industry, it must hold fixed assets, meaning most countries require an entity. If your business is within these industries, entity establishment is your only global expansion option.
2. They have an extensive budget
Setting up an entity costs between $15,000 and $20,000 depending on the country, and around $200,000 per year to maintain, and this number changes based on a variety of factors. This wholly-owned subsidiary option is only suitable for businesses that are ready to make a significant financial investment.
3. They are hiring a high headcount
An organization that has a high headcount in one country with no legal entity raises concern with the government, as this indicates that a firm is potentially using misclassified foreign independent contractors.
Many countries charge severe financial and legal penalties for independent contractor misuse. Establishing an entity and legally converting these contractors to full-time employees is the most cost-effective way to ensure compliance with local laws and regulations.
Entity establishment is a traditional global expansion method, but it is not a realistic choice for many firms looking for a more flexible alternative. The good news is that entity setup is no longer the only compliant option.
Companies that want to test foreign markets quickly, with less risk and a lower financial commitment, must partner with an employer of record (EOR).
An EOR provides a streamlined, efficient solution for overseas hiring. A few benefits of an EOR include:
1. Smaller financial commitment
Entity establishment is expensive and has many surprise costs along the way. An EOR is more cost-effective compared to setting up a foreign subsidiary, and there are no additional costs associated with leaving a market.
2. Quicker setup time
It can take months to establish an entity overseas. An employer of record enables companies to get up and running much quicker than traditional entity setup, which is ideal for short-term projects with tight deadlines or for time-sensitive global initiatives.
3. Flexibility to test new markets
An employer of record is a flexible option for companies looking to test a new market and determine if there is product-market fit. If the move overseas does not work out, it is easier to exit the country because there is no waiting time or additional teardown fees.
Learn more: What Is an Employer of Record (EOR)?
While entity establishment is a viable option for some companies, it is not the only way to compliantly enter foreign markets. An EOR offers many benefits for companies looking to test their global expansion ambitions—with less risk and hassle.
Contact Velocity Global to learn how we can help support your global expansion goals.