Setting up a legal entity is the traditional approach to global expansion. It allows you to establish a physical presence in your target market, build consumer trust, and develop strong relationships with local market players.
However, entity establishment is a costly and time-consuming process that can strain legal, HR, and finance teams. Businesses that choose this route must factor indirect expenses into their budget and prepare for delays of many months to several years.
This guide breaks down the true costs of entity establishment to help you determine if this global expansion strategy makes sense for your business. Find out why companies choose to establish entities, uncover the hidden costs, and discover a flexible and cost-effective alternative.
Common hidden costs of foreign entity establishment
Global expansion is an exciting move. It opens the door to brand development, revenue diversification, and growth opportunities. Still, if you’re considering establishing a legal entity abroad, be sure you understand the true costs of this approach before deciding.
Global organizations must be prepared to take on every cost associated with entity setup to ensure their success. This includes hiring a resident director, paying registration and licensing fees, budgeting for potential noncompliance penalties, and mitigating opportunity costs.
We discuss six hidden costs of entity establishment in detail below.
1. Registered office address
Most countries require foreign organizations to have a physically registered office address to establish a local business entity and receive a tax ID. Real estate and office space costs can be high, depending on exchange rates, market demand, and the space a business needs.
In addition to investing in physical office space, companies must provide technology such as phones, computers, software, and other materials employees need to run their operations successfully, adding to the overall cost of establishing a presence in a new market.
2. Resident director requirement
Most governments have regulations that require foreign organizations to enlist a resident director to represent their local business entity. The resident director is a local employee who acts as a legal representative for the organization, ensuring it meets all its corporate governance requirements.
If hiring a resident director isn’t a requirement in your target market, it’s still wise to hire someone to serve as the local “eyes and ears” of your company. They can offer local market knowledge and expertise, facilitate networking and relationship-building, establish effective communication and cultural understanding, and assist with crisis management.
Organizations must factor sourcing fees and the resident director’s salary into their overall costs, particularly if they need to hire a third-party entity to fulfill this requirement.
3. Ongoing administrative costs
The full entity establishment process can take several months, depending on your target market and expansion goals. However, that’s just the beginning of the required time and financial investment.
Business leaders face administrative costs throughout an entity’s lifetime. For instance, initial setup costs include registration, licensing, banking, insurance, and legal fees while ongoing expenses include legal consultation, running global payroll, regular tax filing, and providing ongoing HR support to an international team.
Maintaining regulatory compliance consumes significant resources as well. Common compliance tasks that require additional resources include the following:
- Correctly classifying talent
- Remitting accurate payroll taxes and withholdings
- Satisfying corporate tax obligations
- Performing annual filings and disclosures
- Meeting statutory benefits requirements
- Ensuring ongoing compliance with employment regulations
- Satisfying other requirements unique to your market
Many companies aren’t experienced with foreign labor and tax laws. Upon entering a new market, they must invest time and resources into educating internal teams, keeping them up to date with changing legislation, and equipping them with the tools they need to ensure ongoing compliance.
4. Noncompliance fines
Navigating foreign regulatory environments always presents major risks and exposes companies to serious fines, litigation, and other penalties. Organizations must ensure global compliance to avoid setbacks as they expand.
Some of the leading compliance risks companies face when operating abroad include the following:
- Global treasury. Organizations must manage cash flows and mitigate risk while handling payments and financial reporting across international borders.
- Transfer pricing. This involves compliantly pricing goods and services you transfer between related entities in different countries.
- Statutory filings and reports. Global companies must submit timely financial and nonfinancial reports according to local language, accounting, and formatting requirements. These include income, tax, social, environmental, and human rights filings and reports.
- Intercompany reconciliations. Global organizations must verify and balance records of shared expense payments they split between common entities or goods and services they transfer between entities.
- Multicountry benefit management. Administering benefits to a global team requires navigating statutory benefits requirements across multiple jurisdictions.
- Employment regulations. These include minimum wage protections, payroll taxes, collective bargaining agreements (CBAs), paid leave entitlements, and more.
Failure to comply with any of the above regulations can expose your organization to hefty fines. Other noncompliance penalties include limited business opportunities, reputational damage, legal injunctions, and even imprisonment.
5. Entity teardown fees
After navigating complex company registration processes and investing many thousands of dollars into establishing a legal entity, the prospect of shutting down operations and exiting the market isn’t a pleasant thought.
Still, exit cost is an important factor for business leaders to consider before expanding internationally. Dissolving a business entity is a complex and lengthy process that usually takes longer and costs more than entity establishment.
Exact costs and time commitments vary drastically worldwide. For instance, dissolving a company in Singapore takes at least four months, while dissolution in Portugal can take up to three years.
Most businesses must complete the following closing responsibilities:
- Completing end-of-year compliance requirements
- Paying off tax liabilities
- Fulfilling employee severance requirements
- Paying back fees due at the time of dissolution
- Paying filing fees for articles of dissolution
Dissolving an entity is more expensive and time-consuming for companies with higher annual revenues and significant headcounts operating in heavily regulated industries like banking.
6. Opportunity costs
In addition to hard costs, businesses often face equally damaging opportunity costs as they undergo foreign entity establishment. Focusing resources on complex accounting, compliance, and reconciliation activities draws attention away from core business activities and results in lost opportunities.
For instance, your accounting and tax teams can develop strategies to minimize costs, optimize analytics, improve decision-making, and mitigate risk in your target market. Still, if you don’t have a substantial employee or business footprint in that region, you will struggle to manage your entity effectively and experience stalled growth.
Time constraints also lead to missed revenue opportunities. On average, establishing an entity and getting up and running in a new country can take one to three years. During this time, your organization can lose market share and revenue.
As you establish yourself in a core foreign market, you may also find traction in peripheral markets that require a local presence but don’t warrant entity establishment. A lean, flexible, and cost-effective expansion strategy is critical for capitalizing on those opportunities.
Remember to take a deeper look at your target market and the opportunities available to your company there to determine whether or not entity setup is necessary.
Want to unlock untapped value in new markets with agility? Download our guide to learn how to quickly and cost-effectively expand abroad, hire top talent, and ensure compliance at every step:
4 reasons businesses may establish a foreign entity
Since setting up an entity is a long, complicated, and expensive process, a natural question arises: How do I know if entity establishment is right for my organization or if I should pursue another global expansion strategy?
In general, establishing an entity makes sense for any company with a substantial budget that wishes to hire a sizable local team and have a long-term presence in its target market.
Below, we outline four reasons businesses choose entity establishment as a vehicle for entering the global marketplace.
1. They must hold fixed assets
Some organizations must hold physical assets in their target markets due to the nature of their operations. As a result, entity establishment is their only option for global expansion.
Imagine a manufacturing company, for instance. It must hold fixed assets, such as plant buildings, production lines, and other advanced equipment, in each market it expands to. Hiring remote talent from abroad isn’t enough. Plus, investing in physical infrastructure triggers permanent establishment (PE) status in most countries.
With such infrastructure requirements, entity setup is the only viable approach. By establishing a foreign subsidiary, the manufacturing company can mitigate risk, clarify tax obligations, directly integrate with other market players, and establish a strong foundation for ongoing growth from day one.
2. They have an extensive budget
Setting up a legal entity usually costs between US$15,000 and US$20,000, depending on the country, plus up to US$200,000 in annual maintenance fees. While these numbers vary based on numerous factors, entity establishment always requires significant upfront and ongoing costs, regardless of the country.
As previously mentioned, these costs comprise physical infrastructure investments, registration fees, legal fees, recruitment expenses, ongoing indirect costs, and other expenditures specific to your target market. Entity establishment isn’t possible if you don’t have the finances to support such a big venture.
Companies with sizable budgets may consider establishing a wholly-owned subsidiary. While this entity structure involves higher setup costs, it helps facilitate direct connections to key local players and strengthens your market presence.
3. They are hiring a high headcount
Entity establishment is ideal if you plan on hiring a high headcount in your target market. It offers reduced risk and excellent long-term growth potential.
For instance, some organizations engage international contractors rather than hiring full-time employees. This option allows you to forgo entity establishment while saving resources you would otherwise invest in hiring and paying a team of full-time employees.
However, an organization with a high headcount and no legal entity may raise concerns with the local authorities. They may audit your company on the suspicion you are using misclassified foreign contractors.
Worker classification designations are highly nuanced and pose a major risk for foreign employers. Even if you haven’t intentionally misclassified talent, you could still face noncompliance penalties, including fines, back pay, and limited business opportunities.
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.
Plus, establishing a local entity gives you control over the entire employment process, from onboarding to offboarding. By handling employment internally, you can reduce long-term hiring costs and build a cohesive, committed team of full-time employees that can grow with your organization.
4. They plan to have a long-term presence in the country
Another reason to pursue entity establishment is if you envision a long-term presence in your target market. If you’re confident about your move and are ready to make substantial investments from day one, then entity establishment is a wise choice.
By establishing a legal entity, you can immediately start developing your brand, building trust among the local consumer base, and strengthening relationships with local suppliers and partners.
A long-term commitment also justifies the high upfront costs. While physical infrastructure, registration procedures, and internal trainings are costly, a legal entity offers increasing returns over time that offset those losses. As previously mentioned, an entity reduces operational and hiring costs and minimizes risk exposure in the long run.
A cost-effective and flexible alternative: Employer of record
While entity establishment offers significant benefits in the long run, it’s not a realistic choice for many firms looking for a more flexible alternative to exploring their global potential.
For instance, some firms want to capitalize on peripheral markets where their product or service is gaining traction but can’t justify undergoing lengthy and costly entity establishment procedures without first proving ROI.
Companies that want to test foreign markets quickly, with less risk and a lower financial commitment, should consider partnering with an employer of record (EOR).
An EOR is a third-party entity with global infrastructure and international legal expertise that makes it easy for companies to quickly and compliantly expand worldwide without having to establish legal entities or worry about violating local employment and tax regulations.
We discuss the benefits of partnering with an EOR in detail below.
1. Smaller financial commitment
An EOR partner serves as the legal employer of your global workforce. They handle all of the heavy lifting and regulatory issues associated with compliantly entering a new market and hiring local talent. This facilitates cost-effective market entry and reduces ongoing operational expenses.
For instance, an EOR partner can manage, pay, and support your global workforce on your behalf, no matter where your team is located.
By eliminating the need for entity establishment and offering a flexible global HR infrastructure, an EOR partner allows you to expand worldwide without facing the high costs of creating multiple entities in each market.
Partnering with an EOR also lets you maintain the option to undergo local incorporation later should your local footprint expand and warrant a more permanent solution. Conversely, an EOR can facilitate a quick and cost-effective market exit should your venture prove unprofitable.
2. Quicker setup time
Another advantage of forgoing entity setup and enlisting an EOR as the legal employer of your global workforce is that you can establish an international presence within weeks rather than months or years.
This is ideal for companies eyeing short-term projects in foreign markets with tight deadlines or other time-sensitive global initiatives.
The rapid setup time also makes an EOR partner an ideal bridge solution for any firm that wants to immediately engage local talent while undergoing banking delays or other time-consuming incorporation procedures.
3. Flexibility to test new markets
In addition to facilitating rapid market entry, an EOR partner allows you to pivot your strategy as you expand. This includes easily testing new markets and quickly exiting without incurring considerable losses.
For instance, if a foreign venture proves unprofitable, you can avoid lengthy wait times, forgo additional teardown and legal fees, and painlessly leave that jurisdiction.
Your EOR partner will help you compliantly offboard international employees and leave them in good standing while protecting your company. You can quickly dissolve your EOR agreement or leverage the EOR to help you seamlessly transition to a more promising market.
Learn more: What Is an Employer of Record (EOR)?
Take the quick, low-risk path to market entry with Velocity Global
While entity establishment is a viable option for some companies, it’s not the only way to compliantly enter a foreign market. An EOR offers many benefits for companies looking to test new markets—with less risk and hassle.
Velocity Global’s EOR solution helps companies of all sizes expand to over 185 countries without undergoing entity establishment or worrying about violating local employment and tax laws.
Whether you’re targeting international talent, creating a new revenue stream, or establishing a low-risk path to a new market, we can provide the agile global infrastructure needed to achieve complex growth milestones.
Our tenured HR and legal experts can offer strategic guidance at every step, such as conducting tailored market assessments and providing financial planning.
We also deliver comprehensive HR support for international teams, including hiring, onboarding, running global payroll, and handling other employment responsibilities so you can continue focusing on other business growth goals.
Contact us today to learn how we can help you compliantly expand anywhere with lower costs and less risk.
Disclaimer: The intent of this document is solely to provide general and preliminary information for private use. Do not rely on it as an alternative to legal, financial, taxation, or accountancy advice from an appropriately qualified professional. © 2024 Velocity Global, LLC. All rights reserved.
