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Internationalization · Strategy

Best Corporate Structure for software business expanding overseas?

Sebastian Stoddart Non-Executive Director at Membr.com

January 16th, 2015

I am currently helping a software startup raise funding in order to expand overseas and we are looking to find the best corporate structure for achieving this. There will be two different models for expansion, either through a distributor license for a region, or through entering a region ourselves.

From what I understand there are 2 options.

1. We could set up a corporation in every region we enter, owned in full by the international holding company. If we were expanding through a distributor then that distributor would have an agreement with the local corporation.
2. We could have a distributor agreement between the international holding company and whoever was running the region, either ourselves or a distributor. This would mean setting up a corporation in the region only if we were entering it ourselves.

Does anyone have experience of this and know which solution would work best from a tax, finance and strategic perspective?

Michael Brill Technology startup exec focused on AI-driven products

January 16th, 2015

So much is dependent on the business, how often you expect to work through distributors, etc. You would need to talk to a tax attorney. In a previous business, we set up a wholly owned sub in France and then worked through a distributor in Japan. The distributor relationship was trivial to manage while the French sub was time-consuming and expensive - but it was something we had to do. Because it'll end up being a wholly owned sub, everything from the sub flows through to your holding company - at least with most GAAP/IFRS countries.

But if you really expect a material amount of money to be involved and you want to employ Apple/Google-class revenue/asset-shifting then you need an international tax/entity attorney.

Michael Burke International Corporate Partner, Arnall Golden Gregory

January 18th, 2015

I agree with what Michael Brill has written.  I've done this--on the legal side--for many US businesses. One of the biggest issues is that forming a sub in each jurisdiction means that you'd have to comply with the local law requirements, as to the activity of that sub. So, that other jurisdiction's corporate law (filing/reporting, etc.), employment law (to the extent that the sub has employees), etc. It's a big compliance burden--not a wrong way to approach this question by any means but it can be a major headache. In many ways, a distribution relationship is a good idea--at least a good first step. You can 'test' the market without investing a ton to form a local sub. You can push many of the local law compliance issues on to the distributor, for example. I would say, too, that one mistake companies make is to not give their distributors a lot of oversight. You'd need to be sure that they are doing their job--proper accounting, protecting your IP, etc. The other discussion you need to have is with your accountant to be sure that, working with counsel, you have a tax efficient structure--perhaps having the international holding company located in a tax-favorable place and have it license/enter into the distribution agreements. There are some US laws that would continue to impact your international operations, too, such as the FCPA and export controls.

Sebastian Stoddart Non-Executive Director at Membr.com

January 17th, 2015

Thanks for the response. Can I ask why the French sub was 'something you had to do'? It's those reasons I'm looking for to help us determine which structure we set up. Thank you.

Michael Brill Technology startup exec focused on AI-driven products

January 17th, 2015

There was no existing entity in France and we were doing that country ourselves as it was much more strategic. Japan was a pure distribution deal with an existing entity. Basically we just treated Japan as a big customer with some extra account management. Given the nature of the business we didn't really have to deal with things like inventory/sell-through, etc. I think we just took a small reserve against all revenue and that was good enough. Again, hard to talk generalities but if you can strike a deal with an existing distributor then it's usually trivial to set up and account for. If you create your own local entity, you've got to hire a local firm to do it, keep it capitalized according to local requirements, create a second set of books, hire a local accounting firm, complicate your local accounting... it's real work. Your tax treatment may be less favorable or more favorable depending on the specifics of your business.

I certainly wouldn't over-engineer a global entity structure if you don't have to. OTOH, it may make all the sense in the world for you.

Sebastian Stoddart Non-Executive Director at Membr.com

January 20th, 2015

Amazing, thank you for all your help.

It seems that its a question of how attractive you think the market is. If it's attractive enough that you don't want to give a large cut to a distributor then you need to set up a local entity and do it yourself. If you think it's not high on your priority list then a distribution model works well, and the aim would be to have as light a touch in the country as possible.

The issue there is as you described. How do you retain control of the clients, protect your IP and manage the distributor, if you don't have a local entity or any control? I imagine it's a case of stipulating the systems they use to manage the business and making sure you have access to those systems. Time will tell.

Thanks!

Michael Burke International Corporate Partner, Arnall Golden Gregory

January 20th, 2015

For lack of a better phrase, diligence is key.  Understanding the market and the distributor/staff you hire for the sub.  Being clear about targets, process, etc. The biggest mistake I see--well, one of the biggest mistakes--is that businesses don't invest time in review/oversight.  Some think that once the contract is signed, their effort is done.  In a distribution agreement, for example, you insist on periodic reporting (against targets/benchmarks), information sharing/reporting on clients' information and audit rights for both--and exercise those audit rights periodically, and not just when you suspect something is wrong. A well drafted agreement at the front end will not just set expectations but can save a later headache.

 

Good luck!

Sebastian Stoddart Non-Executive Director at Membr.com

January 27th, 2015

That's great information and advice, thank you! We're putting in place our accounting and sales practices now and will insist on any sub using the same systems so we can observe them if we want. We also have a full time international sales director whose job is supposed to be keeping an eye on things so hopefully we will be able to stay on top of them. Thanks again for your help.

Joseph Wang Chief Science Officer at Bitquant Research Laboratories

April 19th, 2016

This really depends on the place that you are moving to.  Each different jurisdiction will have it's own tax and regulatory rules.  The rules for setting up in Mainland China turn out to be completely different from those involved in setting up in France.

Generally speaking you want the distributor to set up their own company and for you to have contracts with the distributor.  The distributor can then set up whatever legal structure makes sense for their jurisdiction, and since these two entities are separate and not related, it means that you don't have to hire another team of people to monitor and audit internal transfers.

However, you'll find that in some situations you can't do that.  For example if you want to do something in Mainland China, you may find that there are some legal requirements that will require to you set up a local entity.