What are two potential hidden costs of outsourcing production to a foreign location?

Establishing a foreign subsidiary or 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 need to budget at least $15,000 to $20,000 to get a legal entity up and running in most overseas markets. However, the total costs associated with establishing an entity go far beyond the initial setup phase.

In addition to the initial capital investment, the average direct and indirect ongoing entity maintenance fees average $200,000 per year. This number changes drastically depending on which market you select, the number of employees hired, their required salaries and benefits, and additional factors.

Common Hidden Costs with Entity Establishment

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 before establishing an entity in your chosen market.

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 are 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

On average, it takes 160 hours to research and complete the necessary tasks to set up an entity—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, they 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), higher annual revenues, and a significant headcount to dissolve an entity.

5.) Opportunity Costs

Setting up a foreign entity 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.

Essential Considerations Before Establishing an Entity

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 important considerations that help businesses decide whether or not entity establishment is a viable option for them:

1.) Companies That 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.) Companies with 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. The entity establishment option is only suitable for businesses that are ready to make a significant financial investment.

3.) Companies 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 hiring these workers as full-time employees is the most cost-effective way to ensure compliance with local laws and regulations.

Employer of Record: A Cost-Effective and Flexible Option   

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.

An Employer of Record (EoR) provides a streamlined, efficient solution for overseas hiring. A few benefits of an Employer of Record include:

1.) Smaller Financial Commitment

Entity establishment is expensive and has many surprise costs along the way. An Employer of Record is 60% 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

On average, it takes up to 4 months or more to establish an entity overseas. An Employer of Record enables companies to get up and running in as few as 48 hours, 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 About What an Employer of Record Can Offer Your Business

While entity establishment is a good option for companies, it is not the only way to compliantly enter foreign markets. An Employer of Record offers many benefits for companies looking to test their global expansion ambitions—with less hassle.

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