The Hidden Costs of Entity Establishment
Establishing a foreign entity is a long-term commitment. Before businesses choose this route, they must consider five hidden setup costs.
This article is sponsored by Velocity Global.
This story originally appeared in the May/June 2020 print edition of Middle Market Growth magazine. Read the full issue in the archive.
Establishing a foreign subsidiary or legal entity is the traditional route for businesses expanding overseas. While this method ensures compliance with local laws and regulations, it’s an expensive and time-consuming process that puts a significant strain on internal legal, human resources and financial resources.
Businesses need to budget at least $15,000 to $20,000 to establish a legal entity in most overseas markets. However, the total costs of entity establishment go far beyond initial setup. Establishing a foreign entity is a long-term commitment, so before businesses choose this route, they must consider five hidden entity-setup costs:
Registered office address: Most countries require a physical registered office address to establish an entity and receive a tax ID. Real estate or office space prices might be more expensive compared with the firm’s headquarters location.
Resident director requirement: Resident directors are required for a tax ID, to sign paperwork for a business in the new market, and to go to court in the event of any legal issues.
Ongoing administrative costs: There are both direct and indirect administrative costs, including everything legally required to keep an entity compliant in the foreign market, and training all internal teams.
Entity teardown fees: Dissolving an entity typically takes three times longer and costs three times more than the amount required to establish the entity. In general, it is more expensive and time-consuming to dissolve an entity for companies in heavily regulated industries (such as banking), and those with higher annual revenues and a significant headcount.
Opportunity costs: Companies must consider what they could lose during the average four-month setup timeline, such as revenue or market share as a competitor gains traction.
Since entity establishment is a long, complicated and expensive process, it’s natural to wonder whether a company must establish an entity overseas, or if there are other global expansion options. Businesses must weigh the following factors to determine if entity establishment is the right choice:
Companies that must hold fixed assets: If your business is in an industry that requires a fixed asset to operate, like real estate or manufacturing, you must establish an entity in that market.
Companies with an extensive budget: Although country-specific variables influence cost, entity setup costs are $15,000 to $20,000 on average, and they can cost around $200,000 annually to maintain.
Companies hiring a lot of workers: A high headcount and no legal entity raises concern with the local government, signaling that the firm is potentially using misclassified foreign independent contractors—which leads to severe financial and legal penalties.
International PEO: An Alternative Option
Although entity establishment is a common global expansion method, it is not the best choice for many firms. 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, can partner with an International Professional Employer Organization.
Rob Wellner is chief revenue officer for Velocity Global, a leading provider of global employment solutions. Wellner draws on 12 years of experience in capital markets to help organizations expand internationally, including using Velocity Global’s International PEO service. Learn more at VelocityGlobal.com/acg.