Technology companies, particularly Internet companies, are beginning to contemplate the rest of the world now that the American markets have begun to mature. With only five percent of the world’s population inhabiting the U.S., the populations of Europe, Asia, Africa and Latin America contain large and growing segments of affluence for which the technology fields have great attraction. Now may be an excellent time for companies competing in an established U.S. market to expand their business overseas.
Before venturing overseas, a wise first step is to determine whether the U.S. government can ease access to governmental agencies or private businesses in the target market. A wealth of information and contacts that may assist in penetrating foreign markets can be found at the Treasury Department’s exports desks, the State Department’s country desks and the Office of the U.S. Trade Representative. For certain regions where American investment is consistent with foreign policy objectives, special initiatives may exist that can lower capital costs or enhance the attractiveness of a particular market. In certain areas where the risk of political instability is a concern, the Overseas Private Investment Corp., sells political risk insurance for a relatively modest cost. In addition, the Export-Import Bank insures foreign receivables enabling American companies to leverage their foreign sales.
In some instances accessing the U.S. government can be just as difficult as entering a foreign market. An American company seeking help to go overseas may benefit from consulting U.S. government lobbyists experienced with program availability. A good lobbyist will identify useful programs and will know how to activate the relevant agency and make it work for their client.
Just as the U.S. government has programs to encourage exports and foreign investment, many foreign countries provide incentives to promote the inward flow of capital and technology. The Irish Industrial Development Agency and the Scottish Enterprise are known for their innovative tax and employment incentives. Similar programs exist in countries as diverse as China, Saudi Arabia, Argentina, India and scores of others.
Once an American company has identified a foreign country that it wishes to enter, it should inquire of the embassy or consulate country as to whether the proposed investment may qualify for an incentive program. Again, sophisticated lobbying firms have contacts at many of the embassies or with the foreign governments directly that may expedite this process.
Technology companies are likely to be concerned about intellectual property protection in the applicable market. Virtually all foreign countries have favorable basic patent protection. Similar patent protection for the software components of Internet technology is likely to be in an evolutionary phase in most countries, and copyright and trademark protections are broadly available. Technological information preserved as a trade secret is also respected in many countries.
Before dipping its toes in foreign waters, a technology company should consult with an American intellectual property lawyer with contacts in the countries where protection may be needed. Obtaining the registrations overseas can be expensive. The need for protection should be tempered by a healthy respect for the cost. For most technology companies whose core assets are intellectual, protecting those assets appropriately can make a real difference in the destiny of a company.
Typical structures for a foreign investment include setting up a foreign subsidiary or branch office, acquiring a foreign competitor, establishing a joint venture or creating a license arrangement, distribution agreement or sales representative agreement with a local firm. A creative foreign investment may include elements of each of these structures. Determining which structure is appropriate for a U.S. company requires a careful assessment of the goals of the company and the nature and rules of the market that it is proposing to enter.
Establishing a foreign subsidiary is a fairly simple exercise. Every country of which I am aware has embraced the notion that a corporate entity insulates the owners from liability for its obligations. The formalities associated with establishing and maintaining a subsidiary overseas are often more cumbersome than Americans are accustomed to, but the general principles are similar.
The distinction between a subsidiary and a branch office is that, while a subsidiary is a separate entity, a branch is a division of the U.S. entity. Occasionally, utilizing a branch office can create tax advantages for a U.S. company, but a branch does little or nothing to isolate the domestic U.S. operations from liabilities that arise overseas. It is much more difficult to abandon a failed branch than a failed subsidiary. Therefore, the reasons for using a branch as opposed to a subsidiary should be compelling to justify running the risk that a failed operation overseas will creep back to infect the domestic base.
Acquiring an overseas competitor can accelerate entry into an established foreign market. The process of an acquisition overseas is similar to the American system. The skeleton of the deal is constructed through a letter of intent. When operating overseas, Americans need to be particularly wary in the letter of intent phase. The laws of some countries create binding contracts in surprising circumstances.
As an example, I am familiar with an American company whose principals met with the owners of a Dutch company at a restaurant in The Hague. Great quantities of wine were consumed and wide-ranging deal discussions ensued. Nothing was written down, but at the end of dinner the parties shook hands with great ceremony on an acquisition at a specified price. No other details were specified. The American company was shocked terrified when a letter arrived from the Dutch demanding to close a share purchase before a public notary with no due diligence or written agreement. The lesson: in Holland, a handshake deal can be binding, without anything in writing – no matter how much wine has been consumed.
Differences in culture and language will often require an American business to partner with a local company to ease access to a particular foreign market. While the rest of the world is usually willing to speak English, we may be under an illusion about how well we are actually communicating. Expecting a Japanese businessperson, however good that person’s English may be, to abandon cultural norms is unrealistic. Being unaware or critical of, rather than accommodating to, cultural differences can be fatal to the chance of creating a successful business venture.
Foreign partnerships can take many forms: joint ventures, distribution agreements, sales representative agreements and technology licensing agreements. Typically, a joint venture is a corporate entity, although a joint venture can easily be created by contract alone. A distribution agreement is a contract that shifts the burden of maintaining a particular market to the distributor. Normally, the distributor holds inventory, pays for marketing, is responsible for the credit risk of customers and sets prices and terms for customers; the supplier’s risk is limited to its choice of a distributor. A sales representative, on the other hand, carries no inventory and merely acts as a facilitator for the supplier’s sales in the local market. A technology license agreement transfers rights to technology for a specified term and for a specified compensation, and the licensor often has a commitment to provide training and updates.
Avoiding Legal and
In any foreign transaction, care needs to be taken to delineate between the role of the American lawyer and the foreign counterpart. Both are likely to be required. Few American lawyers will have the knowledge of local law and custom to conclude an overseas transaction without local counsel. Yet foreign law and lawyers can be frustratingly rigid for American businesspeople, particularly in countries whose law is based on the Napoleonic Code. Often, an experienced American international lawyer is essential to bridge cultural gaps and solve problems.
As an example from my own practice, I was once called upon to resolve a logjam that was preventing a deal from closing in Scotland. The law in Scotland is based on the Roman Code, a legal regime that worked well in Julius Caesar’s day. The problems in the deal were legalistic and not fundamental deal points. My American client was extremely frustrated, especially when to each suggested deal structure, the Scottish lawyer intoned, “Ach, no, you canna do that under Scots law!” Ultimately, the deal closed, but without an American lawyer to weave through the cross-cultural and legal minefield, that round deal could not have squeezed into the square hole of Scottish law.
A foreign entity wholly- or majority-owned by a U.S. company is generally treated as an unconsolidated C-corporation for tax purposes and as a subsidiary for accounting purposes. Consequently, it is often the case that the book and tax balance sheets of the American company will show a wide disparity. As an example, a profitable U.S. company with a majority owned joint venture overseas which is in the start-up phase and losing money may show a consolidated loss for accounting purposes yet pay tax on its U.S. gain, thereby exacerbating its after-tax book loss. This is only one example of a trap for the unwary. It is imperative to structure any transaction carefully to avoid or minimize surprising tax and accounting results.
Generally, the repatriation of foreign earnings to the U.S. will result in dividend treatment for tax purposes. If those earnings have already been taxed at the foreign country level, the tax burden is effectively doubled by the repatriation. However, for funds that are not needed by the U.S. parent, it is sometimes possible to avoid tax at the foreign country level and in the U.S. by establishing a holding company in the Cayman Islands or another haven to own the shares in the foreign operating entity. If pass-through taxation treatment in the local country is allowable, the foreign profits may be treated as having been generated through a tax haven operating company where corporate taxes are non-existent or minimal. So long as those funds are never repatriated to the U.S., tax on the gain can be avoided, subject to compliance with certain technical rules.
U.S. Treasury regulations provide that if the assets or more than 66% of the shares of a foreign subsidiary are pledged, to secure a loan in the U.S., the value of those shares or assets may be deemed to have been repatriated for tax purposes. Tax will result to the extent of the foreign earnings and profits unless the transaction is structured to fit within one of several exceptions allowed under the Treasury regulations. Many American lawyers are not aware of these regulations and they represent another trap for the unwary.
Overseas Trade Regulations
A number of U.S. government regulations should be kept in mind when venturing overseas. A technology transfer license may be required from the Commerce Department unless an exception to the technology transfer regulations can be obtained. Certain countries, such as Cuba, Iran and Iraq, are essentially off-limits to most American businesses. Lastly, the Foreign Corrupt Practices Act prohibits American business from engaging in bribery overseas, whatever the local custom may be.
Foreign investment involves risk, and risk promotes hesitation. Yet the world does not slow down and the level of risk may be more perceived than real. While America may be the world’s safest haven for capital, plenty of investor money is squandered in this country while many foreign investments prove highly lucrative. The secret to overseas success lies not in hesitation about risk, but rather in thoughtful implementation of a risk-tolerant strategy that takes into account the law and culture of the rest of the world. t
Author: Jonathan Bell specializes in Corporate Securities at Greenberg Traurig LLP, an international law firm.