Considering global expansion is a huge step in the growth of your company. But while bringing your business to new markets represents an exciting opportunity, it also presents a number of practical and legal challenges.
If you’re looking for the best way forward, you’ll need to know what your options are. This article will outline the main pros and cons of setting up a foreign subsidiary and suggest some alternatives that are faster, easier, and much less expensive.
What is a foreign subsidiary?
A foreign subsidiary is a new business set up in a different country that is partially or fully owned by the parent company—also known as a holding company—in the country of origin. There are a few different types of foreign subsidiaries.
A wholly-owned subsidiary is a type of foreign subsidiary where a parent company owns 100% of the subsidiary's shares. In other words, the parent company has full control over the operations, decision-making, and profits of the subsidiary. Wholly-owned subsidiaries are often established to gain full control over a foreign market, expand operations, or leverage specific advantages in a particular country. This type of subsidiary allows the parent company to maintain a high level of consistency and coordination in its global strategy.
A partially-owned subsidiary, also known as an equity joint venture, is a foreign subsidiary in which the parent company owns a specific percentage of the subsidiary's shares, but not 100%. In this case, the parent company forms a partnership or alliance with a local company or multiple investors in the host country. The ownership structure and decision-making rights are typically governed by a joint venture agreement. Partially-owned subsidiaries are often established to share risks, resources, and expertise with local partners, and they can provide a way to enter a foreign market while mitigating some of the financial and operational burdens.
A joint-venture subsidiary is a specific form of partially-owned subsidiary where two or more companies, often from different countries, come together to form a separate entity for a specific business purpose. In this arrangement, the participating companies contribute capital, resources, and expertise to the joint venture. The ownership, control, and decision-making authority are shared among the partners, usually based on their equity stakes or as agreed upon in the joint venture agreement. Joint ventures can be formed for various reasons, such as accessing new markets, sharing technology or expertise, or pooling resources for a specific project or venture.
It's important to note that the structure and terminology may vary across different countries and legal systems. The specific details and arrangements of foreign subsidiaries can also be influenced by factors such as local regulations, market conditions, and the strategic goals of the parent company.
Why would a company choose to establish a foreign subsidiary?
The most common reason a company would go down the route of establishing a foreign entity is that it ensures compliance with local laws, making it easier to operate and do business in a different market. Additionally, it can help to establish credibility with local authorities and build trust among local customers.
How to set up a foreign subsidiary
Setting up a foreign subsidiary involves several steps and can vary depending on the country and specific circumstances. However, here are some general steps that a company may take to establish a foreign subsidiary:
Step 1: Market research
Conduct thorough market research to identify potential target markets for expansion. Assess factors such as market size, competition, legal and regulatory requirements, cultural considerations, and potential risks and opportunities.
Step 2: Develop a business plan
Develop a comprehensive business plan that outlines the objectives, strategies, financial projections, and operational details for the foreign subsidiary. This plan should align with the overall corporate strategy of the parent company.
Step 3: Ensure compliance with local laws and regulations
Understand and comply with the legal and regulatory requirements of the target country. This may include obtaining necessary permits, licenses, and approvals, as well as adhering to corporate governance and reporting obligations.
Step 4: Determine an entity structure for your foreign business
Determine the most appropriate legal structure for the foreign subsidiary, considering factors such as liability, tax implications, and operational flexibility. Options may include forming a new company, acquiring an existing local company, or establishing a branch or representative office.
Step 5: Financing and securing capital
Determine the capital requirements for the subsidiary and develop a financing plan. This may involve allocating funds from the parent company, securing loans or investments, or partnering with local investors.
Step 6: Develop local partnerships
If necessary, identify and establish partnerships with local companies or individuals who can provide market knowledge, distribution networks, or other resources. This is particularly relevant in partially-owned subsidiaries or joint ventures.
Step 7: Set up operations
Establish the necessary infrastructure, facilities, and operational systems for the foreign subsidiary. This includes hiring and training employees, setting up accounting and IT systems, and securing supply chains and distribution channels.
Step 8: Enter the market
Execute the market entry strategy, which may involve marketing and advertising campaigns, sales and distribution efforts, and building relationships with customers, suppliers, and other stakeholders in the target market.
Step 9: Monitor and evaluate
Continuously monitor the performance of the foreign subsidiary, assess its progress against the business plan, and make necessary adjustments to achieve the desired outcomes.
How much does it cost to set up a foreign subsidiary?
It’s impossible to estimate the exact costs of opening a foreign subsidiary as each case will differ. To give you a rough idea, some of the costs might include:
- Registering with the local authorities: $4,000–$15,000
- Opening a local bank account: $1,000–$5,000
- Appointing a local director: $4,000–$15,000
- Setting up a registered office: $40,000–$50,000
- Onboarding your team: costs will vary depending on factors such as visas, local salary rates, taxes, and benefits
Compared with Oyster’s price for hiring employees in other countries starting at just $499 per employee/month, and just $29 per contractor/month, it’s clear to see why opening a foreign subsidiary is not the best route for every company looking to expand abroad.
How long does it take?
The complete process of setting up a foreign subsidiary can take anywhere from four to twelve months from start to finish. And if you decide to exit the country, it can be just as difficult and costly. For example, in China, there are several steps you need to take in order to cancel, dismiss, and liquidate your company, and the entire process can take three to four months.
Setting up a foreign subsidiary: pros
Here are four of the main advantages of opening a foreign subsidiary.
1. A larger global presence
Setting up a subsidiary in a foreign location allows the parent company to expand its reach and make a bigger impact on the world.
This includes access to different markets and more opportunities for expansion. For example, if the market is already saturated in the home country, opening a foreign subsidiary in a country with less competition can provide opportunities for increased revenue.
In other words, setting up a foreign subsidiary can help your business continue growing when remaining only in your home country might stifle growth.
2. Streamlined processes in host countries
Some countries welcome foreign investment and make the process of incorporating a company simple, sometimes even extending incentives such as:
- Tax incentives
- Free trade zones
- Few restrictions on ownership of foreign companies
- No minimum capital requirement
- Special economic zones
- A faster incorporation process
3. Access to local knowledge
Setting up a foreign subsidiary allows businesses to hire local employees who have greater knowledge of the local market and business opportunities available. It also makes it easier to establish relationships and partnerships with local organizations and take advantage of their networks and local expertise.
4. Recruiting local talent
Another reason to open a foreign subsidiary is to gain access to local talent and their technical skills. In today’s ever-changing tech environment, some countries are ahead of the curve.
For example, countries such as Japan boast highly skilled workers whose technological knowledge is in high demand. Establishing a legal presence in these countries allows businesses to tap into the local talent pool.
Setting up a foreign subsidiary: cons
Now let’s take a closer look at three of the biggest disadvantages of foreign subsidiaries.
1. It's expensive and time-consuming
Setting up a subsidiary is an expensive business. While costs vary wildly from one country to another, you can conservatively expect the bill to run into hundreds of thousands of dollars.
In addition to the costs of opening the foreign subsidiary, you may need to take into account additional expenses such as travel to the country to attend meetings and sign documents.
Adding to that the time it takes to set up and shut down the subsidiary, you can see that this route of global expansion is not for the faint of heart.
2. Ownership laws can be complicated
Many countries are reluctant to allow companies that are wholly owned by a foreign entity to set up camp on their soil.
For example, the UAE requires foreign investors to have a local, UAE-citizen partner who owns at least 51% of the company’s stock in order to set up a subsidiary in that country.
Some countries prohibit foreign ownership in certain industries, while others may allow a foreign investor to put a certain amount into the company. Navigating these rules is a complex and time-consuming process.
3. Compliance can be tough to manage on your own
One of the biggest challenges with setting up a foreign subsidiary is doing so compliantly. Many countries have tricky rules around hiring staff, managing payroll, abiding by tax laws, and providing benefits to employees.
Are foreign subsidiaries risky?
There are many compliance and tax risks that come with opening a foreign subsidiary that vary from country to country. Take a look at our global hiring guides to get a flavor of how labor laws alone differ drastically from country to country.
One of the biggest risks to be aware of with a foreign subsidiary is to make sure it doesn’t meet the criteria for a permanent establishment, as this can significantly increase the costs and tax obligations for the parent company. In brief, if a company is deemed to have a permanent establishment in a particular country, that means the company has a taxable presence there—in other words, it is required to pay local taxes. Find out more in our guide to avoiding permanent establishment risk.
As you can see by now, setting up a foreign subsidiary is a vast and costly undertaking, with many potential risks and pitfalls. Fortunately, foreign subsidiaries are no longer the only way to enter a foreign market or set up a global remote team, and many simpler and more economical alternatives are available today.
EOR vs. foreign subsidiary
If you’re seeking quick entry into an international market and want to save on costs, an employer of record (EOR) might be a better option. However, if your business is looking to expand into multiple countries, the process of researching and partnering with several EORs can become costly, confusing, and time-consuming. Learn more in our guide to EORs vs. foreign subsidiaries.
What about a global employment platform (GEP)?
If you’re looking for quick entry into several global marketplaces, or are simply looking to onboard new team members across borders, a global employment platform like Oyster might be the right option for you.
GEPs are a fantastic way to onboard, pay, and provide benefits to talent across the world from a single platform. It’s a good way to test the waters in a new talent market without the cost and resources required to set up a subsidiary.
How Oyster can help you hire abroad with ease
Oyster enables you to quickly and easily engage talent from over 180 countries worldwide. All Team Members are managed from a single platform where you can see all the relevant information. Compliance with local laws is handled for you, and customer support is always on hand to help you figure out the intricacies of international hiring. Find out more about how Oyster can help you hire globally.
Oyster is a global employment platform that empowers visionary People Ops leaders to manage and care for a thriving global workforce. Through its compliant hiring process, streamlined payroll, and localized benefits offerings, companies can bring talent aboard no matter where they're located.