Overseas founders and employees: What do I need to know?

Businesses face several considerations when onboarding founders or employees who reside in foreign countries. These issues also apply to U.S.-based founders and employees who move to a foreign jurisdiction and work remotely.

Bottom line, having founders and employees located in a foreign country is too practically burdensome and expensive for most early-stage startups.

Don’t Do Business in a Sanctioned Country

The U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) maintains lists of sanctioned countries and may block assets and impose trade restrictions on transactions involving these countries to accomplish foreign policy and national security goals. You should avoid doing business in these countries, and if you’re considering using the services of an individual or entity based in a country that is subject to sanctions, you should seek legal advice before doing so.

Don’t Work With “Specially Designated Nationals” (SDNs)

Similarly, OFAC maintains a list of individuals and companies with which U.S. persons are generally prohibited from dealing. You should avoid doing business with any of these individuals or companies.

You Will Be Subject to Foreign Taxes

Most countries have rules for when a foreign company has “permanent establishment” within their jurisdiction, thereby subjecting the company to taxes in that country. The United States has tax treaties with many countries that set out those rules, but if there is no tax treaty, then the foreign country can have its own rules for what permanent establishment means. In general, if a company has an employee in a foreign country for 181 or more days in a year, the entire company will be subject to taxes in that country. This will complicate the company’s U.S. tax return as well.

For this reason, U.S. startups and other small businesses should be wary of establishing a local subsidiary or affiliate and hiring employees in a foreign country unless they are prepared to deal with foreign taxes, including filing foreign tax returns and paying foreign taxes.

Foreign Laws and Claims Will Apply

When you have employees based in other countries, you must administer payroll (often through a local payroll agent) and otherwise comply with all applicable laws regarding employment and employee benefits in those countries. You are also subject to labor and employment claims by those employees under the laws of those countries if the relationship goes sour. This is a common occurrence, and often the risk of claims by disgruntled employees is greater than the risk of a foreign government coming after you for a violation of local law.

Also, if you plan on issuing stock or employee equity to your foreign employees, you will need local counsel to ensure the stock issuance complies with local securities laws. This often is in the form of an “addendum” to your standard equity incentive plan, but it varies depending on the country.

Finally, using foreign agents and doing business in other countries will subject you to a bevy of U.S. laws designed to prevent corrupt practices, criminal activity, and endangerment of U.S. national military, diplomatic, and economic interests.

The extent of this additional and uncertain legal exposure is another reason that U.S.-based startups should be wary of establishing a presence internationally unless they are prepared to deal with the increased costs and burdens of compliance with such laws.

It May Be Harder to Protect Your IP

Protecting your intellectual property is one of the most important measures in maintaining the enterprise value of your startup. When your IP is generated and located within foreign jurisdictions, the typical U.S.-style protections that startups expect may not apply. Also, foreign laws may grant employees rights in certain types of IP in certain circumstances, thus casting doubts as to whether your company fully owns its IP.

Founders vs. Employees

In the United States, founders and employees are often treated as one and the same for purposes of employment laws and the need to pay minimum wage and benefits, etc. Some foreign countries may have a similar approach, but others may have less sympathy for founders bringing credible labor and employment claims as independent employees given their ownership stake. That varies country by country, so it’s safest to assume founders will be treated similarly to employees for purposes of local laws.

Practical Alternatives

International PEOs. Many companies offer international professional employment organizations (PEOs) that serve as HR outsourcing in other countries and assist companies with the management of employment-related tasks, including employee benefits, compliance with local regulations, servicing payroll, and managing labor and employment risk. The principal downside of international PEOs is that the liability and responsibilities of employment still rest with the client even though the PEO can help minimize compliance risk.

GEOs and employers of record. Other companies, known as global employment organizations (GEOs), offer to serve as the employer of record (EOR) for foreign employees. The employees become fully employed by the EOR and a service agreement exists between the EOR and the client. As a result, the EOR has all responsibilities for employment, liability, insurance, company registration, and statutory requirements. EORs/GEOs are more protective of the client than an international PEO, but are also more expensive.

Foreign consulting companies. Another practical alternative might be contracting with a foreign consulting company to establish a local affiliate and hire foreign employees. This arrangement is typically structured as follows: an independent contractor in a foreign country operates its own consulting company formed under the laws of that country, and the U.S.-based startup enters into a consulting contract with that company. This does not avoid all of the above issues, but it may mitigate some of your company’s exposure to local laws and taxes.

How to Prepare for an Equity Financing

We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.

What Every Startup Needs to Know

On Wednesday, June 26th, Perkins Coie’s Palo Alto office hosted the startupPerColator event, “What Every Startup Needs to Know.” Lowell Ness, a Perkins Coie partner in the Emerging Companies & Venture Capital (ECVC) practice, moderated a panel which included Herb Stephens of NueHealth, Thomas Huot of VantagePoint Capital, Jennifer Jones of Jennifer Jones and Partners, Yuri Rabinovich of Start-up Monthly, and Olga Rodstein of Shutterfly.