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A brief overview of the basic legal aspects every startup should consider when venturing abroad to ensure regulatory compliance
Entrepreneurs need to have an intuitive understanding of their base country’s social, economic, legal, and cultural dynamics. This serves several purposes: allowing for better understanding of the target market, adjusting quickly to changes in demand, and keeping abreast of changing regulation more easily.
Although operating in domestic markets offers these advantages and a sense of familiarity to founders, international expansion is a natural ‘next step’ in a startup’s growth trajectory.
Not only does expanding across borders allow startups to break out of saturated markets, it also offers access to a new base of consumers, and helps diversify market risks and gain competitive advantages.
While overseas expansion can pose several financial and business challenges, legal considerations should also rank high on the priority list. Differing laws and taxation policies, as well as business operating regulations, directly impact a startup’s revenue-generation potential in that market.
Below are some common legal considerations for startups planning on expanding beyond their countries of origin.
1. Business Structure
When expanding outside a startup’s domestic market, founders need to evaluate the different business structures available in the secondary market and see which one best suits their goals. It is important to remember that each structure offers a different level of integration into the local market, and varying degrees of risk.
The most commonly-used vehicles for international expansion include the following:
- Commercial Agents: Launching a product or service in a new market comes with a considerable up-front cost, meaning that entrepreneurs need to do comprehensive due diligence before going all in. To facilitate this and lower the risk, a startup can choose to contract commercial agents in the new market to conduct initial sales and promotions for the startup’s goods or services. Commercial agents act as independent intermediaries to promote the sale of goods and services on another company’s behalf, allowing the brand to gain visibility in a new target market. This business structure allows the startup to test consumer response to its product in the new market without incurring the financial costs and legal burden of setting up a subsidiary or branch. It also considerably reduces the risks of startup failure in international markets. If the startup finds little demand for its solutions, it can easily discontinue its services and focus on markets with more potential. It is important to note, however, that selling products and services in a foreign country may subject startups to taxation and other legal obligations, since consumers are protected by the laws of the country.
- Distributors: Like commercial agents, a startup can also use local distributors, or an international distributor with networks in its target market, to export its products and services. Unlike commercial agents, however, distributors purchase products outright and assume the risks of selling them in their local market, thus absolving startups of the responsibility. The primary advantage to startups is that distributors offer a way for them to increase their revenues while reaching a larger consumer base and taking on minimal risks and legal obligations.
- Representation Offices: Startups can choose to set up representation offices at strategic locations in the target market in order to build a relationship with the local buyers and sellers. Representation offices can be used to execute marketing, promotional and other non-transactional operations. Since these offices cannot be used for sale of goods and services, they less regulated and therefore easier to establish than subsidiaries and branches.
- Subsidiary or Branch: A subsidiary is a legally independent entity and is usually established to duplicate a startup’s business model in a foreign market. A foreign branch, on the other hand, is part of the same business, and is simply an office in a foreign market. Both subsidiaries and foreign branches are subjected to the operating guidelines, tax structure, and other business laws of the country. However, they differ in two ways: the degree of control the parent company has, as well as the percentage of taxation. Subsidiaries abroad are considered domestic companies and their taxation is usually on par with other companies in that country. Foreign branches, on the other hand, are usually subjected to higher taxes and a more cumbersome process, although they offer startups greater control over their operations.
- Joint Venture: Establishing a joint venture allows a company to leverage the knowledge and experience of local partners, reducing the risk of failure. Companies also benefit from local taxation laws as they would if they opened subsidiaries, making joint venturing an attractive option.
In some instances, a startup may not have a choice between the various methods of expansion: countries like China, Iran, and the United Arab Emirates have laws that prevent foreign companies from operating within their borders unless they strike up a local partnership – highlighting once again the importance of being aware of local regulations before entering a new market.
2. Laws governing international sales contracts
Startups need to sign international sales contracts in order to work with commercial agents or distributors, or sell direct to customers. Well-drafted sales contracts specify the terms of the sale, identify the laws governing the contract, specify methods of dispute resolution – litigation or arbitration – and lay down terms of indemnification in case of contract termination.
Drafting these contracts carefully ensures that both parties are clear on their roles and obligations, and helps to prevent penalties or compensation demands in case of a dispute.
Sales contracts must usually adhere to local regulations, and in cases of sales agreements with end users, startups may be legally obligated to translate them into the local language. This is a smart move regardless of legality, as it will make things clearer for consumers, and help to prevent complaints and penalties later on.
3. Employment laws
Needless to say, operating in a foreign country requires startups to seek local employees and contractors. While it may offer the startup access to a greater talent pool, it is also important to consider employment laws in the target market.
In order to minimize chances of dispute and to prevent employees from raising potentially harmful claims against a startup, it is best to structure employment agreements and contracts with explicitly clear terms. These contracts and agreements should specify job roles and responsibilities, a clear delineation of the management structure, and the compensation and benefits the employees are eligible for.
Startups can also explore adding clauses like ‘at-will employment,’ which offers the freedom to terminate employment agreements without warning, or a ‘non-compete’ clause that can temporarily restrict former employees from working with competitors.
However, founders need to carefully explore the enforceability of such clauses in their target jurisdictions. For instance, while a non-compete clause is enforceable in the U.S., it isn’t recognized in India.
Incidentally, as employers, startups need to ensure compliance with all local employment and payroll obligations, failing which there may be consequences that threaten the startup’s operations.
4. Product and service liability
Product- and service-related complaints can pose major issues for startups that haven’t carefully reviewed documentation and rules governing consumer goods in a new market.
Startups need to conduct a meticulous assessment of all information and claims displayed on their website, brochures, and promotional materials. The idea is to ensure that all product- or service-related information is clearly communicated to consumers, including usage guidelines, warranties, product installation instructions, and potential risks.
This due diligence can prove to be a useful preventative measure, and protect startups from lawsuits and punitive damages. Moreover, startups may also consider insurance policies for contingencies in case of product- or service-related lawsuits.
Additionally, some countries have laws that mandate the declaration of certain product related information, the ignorance of which can result in heavy penalties. For instance, in India, ecommerce websites are now required to clearly state the country of origin of products offered for sale online.
5. Intellectual property (IP)
The IP of a business encompasses trademarks, patents, design rights, logos, inventions, trade secrets, and everything else that has been specifically developed by the company. Having IP gives startups a competitive advantage, and creates a unique identity, product and service that customers will come to recognize.
Therefore, startups are required to register their trademarks and other pieces of IP before launching their businesses on foreign soil. This serves the purpose of protecting a brand’s unique identity and prevents potential IP infringement lawsuits, while also preventing other businesses from using the same IP.
6. Data protection laws
Over the last few years, consumers have become more cautious about sharing their data, and countries around the world are implementing strict data protection laws to ensure consumer privacy and prevent data misuse. Therefore, it has become increasingly important for startups to evaluate target markets and their data protection laws before expansion, in order to accurately gauge the costs of operation.
Some countries, for instance, have strict laws about which data can be collected, how they can be used and for what purposes, and even how and where they can be stored. For example, China requires certain sensitive data generated and collected in the country to be physically and exclusively stored within its geographical boundaries.
While the percentage of taxation varies from country to country, the common goal of all tax authorities is to maximize contributions from businesses operating within their jurisdictions. Reviewing tax laws carefully is an important part of due diligence before entering a new market.
Sometimes, there are certain international agreements between countries that seek to encourage trade by lowering companies’ tax obligations. Startups can therefore explore markets that have such agreements with their domestic market in order to avoid heavy taxation.
Additionally, startups can also review tax structuring options to potentially reduce their tax burden. Startups should also familiarize themselves with local payroll tax laws to ensure compliance.
Although the above listed legal considerations are not exhaustive, they offer a brief overview of the basic legal aspects that need to be evaluated while entering foreign markets. It is advisable to seek local legal counsel while undertaking expansion projects to ensure complete understanding of the local laws and legal obligations of startups, and the associated costs and impact on business and revenue.