A foreign subsidiary is an excellent way to expand your business globally. However, there are many things to consider before setting up such a company.
In order to set up a foreign subsidiary, you must first determine whether or not it makes sense for your company. Find out more about the pros and cons of this strategy. Setting up such a subsidiary is a great way to expand your business internationally. However, you should be aware of some important considerations before making a move.
What is a Foreign Subsidiary?
Foreign subsidiaries are companies that operate outside of their parent company’s country of origin. They may be based in another country or even a different continent. Foreign subsidiaries are often used as a way to expand a business’s reach. In fact, they’re so common that there are actually laws governing them. You might not have heard about foreign subsidiaries before, but you’ve probably seen them on TV.
The designation of a foreign subsidiary relies on how much of the company is possessed by the parent company, as follows:
- A controlling interest in more than 50% of the stock of a subsidiary is usually held by the parent company
- A fully owned subsidiary is one in which the dominant company holds 100 percent of the stock in the foreign subsidiary
- The designation keeps changing to associate or affiliate company if the ownership stake is less than 50%.
In terms of structure, a subsidiary operates independently of its parent company, is responsible for its own assets and liabilities, and is treated as a separate legal entity for taxation and regulatory oversight by the subsidiary where the company is based. In other words, US laws do not apply to foreign subsidiaries; they are governed by the country’s laws in which they operate.
The overall makeup of the foreign is something that a parent company can control.
The Parent Company Can Take The Following Steps:
- Create a board of directors to govern the company
- Create a foreign subsidiary on your own terms, without the need for shareholder approval
- Without shareholder approval, you can sell a subsidiary.
Pros and Cons of a Foreign Subsidiary
Like any other significant business venture, foreign subsidiaries have benefits and drawbacks. These elements are at the top of the priority list:
Pros of a Foreign Subsidiary
A company that establishes its very own foreign subsidiary wields significant influence over how that subsidiary is run. The parent company can take a ‘top-down’ approach to instill its own unique culture, values, and vision in the subsidiary by installing its own board of directors. On the other hand, the subsidiary reaps the benefits of the parent company’s valuable shared resources, such as financial systems, technology systems, sales and marketing expertise, and a plethora of business opportunities. These resources allow the subsidiary to immediately shift into a higher gear and compete more effectively in its market.
Entry Into Profitable New Markets
‘If a company isn’t growing, it’s dying,’ as the adage goes.
Similarly, establishing a foreign subsidiary allows the parent company to grow and expand into regions and industries where it would otherwise be unable to do so. New foreign markets bring new customers and sales opportunities, allowing the parent to expand its brand in financially valuable foreign markets.
A Foreign Subsidiary Earns More Credibility—and Protection—overseas.
Companies that establish a subsidiary in a foreign country are generally taken more seriously by local industries, governments, and business affiliates than companies that simply open a branch office there.
Foreign financial institutions, for example, are more willing to do business with a foreign subsidiary that has received the legal and fiscal stamp of approval from the local and national governments where the subsidiary is located.
Furthermore, a parent company’s liability for its foreign subsidiary is limited.
For example, suppose a subsidiary is involved in litigation. In that case, the subsidiary, not the parent or holding company, is liable, ensuring protection from any significant financial penalties that may arise from legal issues overseas. Furthermore, suppose a subsidiary fails to meet expectations (or worse). In that case, the parent company can quickly sell it, often to another company in the very same foreign country.
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Cons of a Foreign Subsidiary
Costs Can Accumulate
The cost of establishing a foreign subsidiary, both economically and in terms of time, can be substantial.
While costs vary by country, it’s frequent to see capital requirements of several hundred thousand dollars and timelines of six to nine months when establishing entities in foreign countries.
Furthermore, some country legal mandates require parent companies to send staffers on-site to sign documents and attend specific meetings, adding costs and time to the bottom line.
Exiting a country where you’ve set up a foreign subsidiary can be costly and time-consuming, as statutory filing fees can take months to pay. Liquidating a wholly-owned subsidiary in China can take anywhere from eight to twelve months.
Companies considering establishing a foreign subsidiary should conduct a five-year financial feasibility study.
Cultural Differences
Cultural and commercial integration in a foreign country may be challenging for American businesses.
Operating in a foreign country often entails dealing with the various bureaucratic, political, rate of exchange, legal issues and processes, and language, currency, and physical distance issues. To protect the organisation from various compliance risks, local knowledge and experience versed in the nuances of the local requirements are required.
Staffing Acquisition And Onboarding Issues
Recruiting new talent from outside the country presents its own set of challenges for a parent company’s human resources department.
When running a foreign subsidiary, inside knowledge of local job postings, conducting interviews, job offers, benefits, and onboarding is not a luxury. It’s a necessity.
Is a Foreign Subsidiary a Good Option For Your Company?
The decision to establish a foreign subsidiary is based on your company’s specific long-term business objectives. That process begins with a thorough examination of your company’s financial, logistical, and management capabilities and where your best ‘fit’ might be in another country.
It’s also good to run some internal circumstances to see if a subsidiary makes more sense than simply opening a branch office in another country.
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