By Globalization PartnersSeptember 2019
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If your company is looking at foreign markets for business expansion, one of the most important questions you need to ask yourself is whether you want to open an overseas branch or a foreign subsidiary. How you answer the question depends on the opportunities you perceive in a new market as well as your appetite for regulatory and cultural challenges in a new country.
While some business challenges remain the same no matter where you are located, other challenges are very specific to a given country. Some of the questions your company may need to answer include:
- Do you first need to create a legal entity in that country?
- What are the visa requirements?
- What about work permits and residency permits for employees?
- If you follow all the rules and regulations of a foreign country, how long will it take before your company is able to legally do business?
After thinking through those questions, you can then ask yourself: Should we open a branch or a subsidiary?
What Is the Difference Between a Branch and a Subsidiary?
When deciding whether your company wants to open a branch or a subsidiary in a foreign country, you need to decide what your primary business interest will be, what your goals for the branch or subsidiary will be and how you will handle questions of taxation and liability.
We’ll provide a primer below, but here’s a short breakdown of the difference between a branch and a subsidiary.
A branch typically has the following characteristics:
1. A Branch Is Connected to the Parent Organization
A branch is created by the parent company to perform more or less the same business as the parent company, but at a different location. A good example would be bank branches in the United States. Well-known banking companies such as Wells Fargo, BB&T, or TD Bank have branches set up across the country that all engage in the same business as the parent company, which, in this case, is banking.
2. A Branch Office Reports to the Head Office
All branches are ultimately responsible to their head offices and report all their important data and information to the head office.
3. A Branch Office Normally Maintains Joint Accounts with the Head Office
In a branch office, account maintenance can be done separately or jointly, although in most cases it is done jointly with the head office.
4. A Branch Office Is Completely Controlled by the Parent Company
A parent company will always have 100% ownership of a branch office. Whether the branch office is in the United States or in a foreign country, there are no partnerships or joint ownerships of a branch office.
5. The Parent Organization Owns 100% of the Liability of the Branch Office
If a branch office is involved in a lawsuit or litigation of any kind, that means the liability extends to the parent organization. So, if a branch can’t discharge its liabilities, any fines, settlements, or charges will need to be paid by the parent company. A branch office does not have a separate legal identity.
6. If a Branch Office Loses Money, it is Closed
If the parent organization opens a branch office in a foreign country and discovers that it is losing money or that its chance of being profitable in the future is slim, it can close the office.
The individual in charge of a branch is known as the branch manager. While they are directly responsible for the activities of the branch, they take instructions from and report to the head office.
A subsidiary generally operates based on the following:
1. A Subsidiary Is Ultimately Owned by the Parent Company but Operates as a Separate Entity
A subsidiary company is an entity where the controlling interest is either totally or partially held by another company, often known as the holding company. In that case, the parent company either has a total or a majority ownership stake.
2. The Subsidiary Reports to the Holding Company
A subsidiary, unlike a branch office, does not report to the parent organization. Instead, it reports to the holding company that controls it.
3. In Most Cases, a Subsidiary Will Not Perform the Same Business as the Parent Company
Sometimes a subsidiary will conduct the exact same business as the parent company. At other times, however, it may engage in businesses that are totally different from what the parent organization does. For instance, if the parent company is involved in the oil business, a subsidiary may work in retail or in telecommunications.
4. A Subsidiary Maintains Its Accounts Separately from the Parent Organization
The subsidiary does not maintain its accounts with the parent organization. Instead, it is solely responsible for maintaining accounts on its own.
5. The Parent Organization Has a 51% to 100% Ownership Stake in the Subsidiary
Ownership stakes in a subsidiary depend upon the regulations of each individual country. For instance, in Saudi Arabia, a subsidiary can be 100% owned by a foreign company. Other countries, however, may require a local ownership stake in any subsidiary. In Algeria, a foreign-owned import business must include at least a 30% Algerian ownership of that entity.
6. The Parent Organization Has No Liability for the Subsidiary
If a subsidiary in a foreign country is involved in any kind of litigation, any liability is limited solely to the subsidiary and does not involve the parent organization. A subsidiary has a separate legal identity from the parent organization.
7. If a Subsidiary Loses Money, It Is Often Sold to Another Company
Unlike a branch, which closes if it loses money, if a subsidiary fails to turn a profit or does not look like it can sustain a profitable future, it is usually sold to another company within that foreign country.
What Are the Pros and Cons of Operating Either a Branch Office or Subsidiary?
So what are some of the pros and the cons of operating either a branch or a subsidiary in a foreign country? Either operation offers the parent organization different benefits as well as different challenges. As we noted above, ultimately the parent organization needs to make a choice between a branch or a subsidiary based on what they hope that particular business operation will accomplish.
Some of the pros of operating a branch include:
1. A Parent Organization Maintains a Greater Level of Control Over a Branch Office
Since a branch office reports to the parent organization and receives all its instructions from it, the parent company has a much greater role in the decision-making process.
2. A Branch Office Is Mostly Governed by the Laws and Rules of the Country Where Its Parent Company’s Head Office Is Located
While there will always be some local rules and regulations that a branch office will need to follow when located in a foreign country, these will have a limited effect on a branch office. This means the parent organization can more effectively manage the branch.
3. It Costs Less to Establish a Branch Office
Once a parent company receives permission to open a branch office in a foreign country, it is a much easier and cheaper process to get it up and running. For instance, a branch office does not have to spend time negotiating a local ownership stake, and in many cases, its overhead costs comprise renting office space and paying for staff.
4. A Branch Office Offers the Parent Company Greater Tax Benefits
In most cases, the revenue earned by a branch office will be handled by tax treaties signed between the company where the parent organization is located and the country where the branch office is located. These treaties eliminate double taxation. So, if the branch office needs to pay taxes in the foreign country, these taxes are counted toward the parent company’s tax bill in the United States.
5. A Branch Office Is the Simplest Form a Business Can Take to Expand Its Opportunities
The branch office is the simplest and safest way for a company to expand its brand to a foreign country and to explore new markets and other places.
Some of the pros of having a subsidiary include:
1. Subsidiaries Are Independent of Their Parent Organization
Since a subsidiary in a foreign country is a separate legal entity, this makes it easier for them to conduct business, to form partnerships, and to explore new markets.
2. A Subsidiary Adds Greater Credibility to the Parent Organization
In many cases, service providers and banks in foreign countries are happier doing business with a subsidiary for both legal and financial reasons.
3. A Subsidiary Is More Flexible Than a Branch
A subsidiary enjoys a greater degree of flexibility because it can issue or transfer shares to third parties like investors, partners, employees, or venture capitalists. Since a subsidiary can be listed on the stock exchange, it can also issue public stocks or bonds.
4. A Subsidiary Can Explore More Economic Opportunities in a Foreign Country
While a branch basically conducts business similar to its parent organization, a subsidiary can explore new economic realities in a foreign country. So, while the branch office of a retail organization will primarily stick to retail, a subsidiary might be interested in exploring the pharmaceutical market in the same country.
5. A Subsidiary May Be Able to Take Advantage of Cost Efficiencies in a Foreign Country
A parent organization that opens a subsidiary in a foreign country is often able to take advantage of the country’s labor and manufacturing costs.
6. A Subsidiary Offers Greater Liability Protection for the Parent Organization
Since a subsidiary has a separate legal identity, it offers greater legal protection for shareholders of the parent organization who will have no liability if the subsidiary falls into debt or suffers legal problems.
What Are the Problems with Opening a Branch or Subsidiary?
While these may seem like attractive incentives, opening an overseas branch or a foreign subsidiary also has its share of challenges and issues. While opening a branch or subsidiary in some countries is relatively straightforward, other countries have complex legal requirements and labor laws that can significantly delay a parent organization’s desire to enter a new market.
Cons of Opening a Branch
Some of the cons of opening a branch include:
1. A Branch Office Makes It More Difficult for the Parent Organization to Explore New Business Opportunities
Since a branch office is largely restricted to the activities of the parent organization, this makes it more difficult to expand into other potentially profitable areas.
2. If the Branch Office Incurs Debts or Suffers Legal Problems, the Parent Organization Is Liable
Unlike a subsidiary, a parent organization is 100% liable for any debts, fines, or legal settlements that a branch office is obligated to pay. It also places the shareholders of the parent company at risk.
3. Finding Employees for the Branch
Depending on a foreign country’s labor laws, it can often be more difficult to bring in workers from the United States to work in a foreign country. Visa requirements and work permits can often be difficult to obtain, and a branch office may only be allowed to employ a certain number of foreign workers due to quotas.
Cons of Opening a Subsidiary
For a subsidiary, some of the cons include:
1. A Subsidiary Costs More to Establish and Open
As we noted above, a branch office often only requires office space. A subsidiary, on the other hand, may require manufacturing facilities and face more complex legal issues such as local ownership and how a subsidiary is taxed. It is important for the parent company to do its financial due diligence when considering opening a subsidiary.
2. A Subsidiary Faces Regulatory and Cultural Challenges in a Foreign Country
While a branch office faces some of the same issues because it is mostly controlled by the parent organization in the host country, these issues are not as onerous. A subsidiary, however, operates solely in a foreign country. This means any parent organization that wishes to open a subsidiary must carefully study the cultural, political and regulatory environments in that foreign country. This is actually a strong argument for some percentage of local ownership in a subsidiary. Owners who live in the foreign country can help the parent organization better understand how the country works.
3. Costs Can Be High If There Are Problems
If a branch office proved troublesome, the parent organization can just close it. If a subsidiary proves to be a problem in terms of profit or revenue, there are much more intricate legal and financial questions involved. Often a money-losing subsidiary will be sold to another company in the foreign country, and this could result in complex and costly legal and financial negotiations.
Let Globalization Partners Help You Establish a Presence in a Foreign Country
Deciding between a branch office and a subsidiary in a foreign country can be a complex and difficult issue, particularly if you’re interested in expanding into another market as quickly as possible. It not only takes time for your operation to decide how it would like to be represented in a foreign country, but then it also takes time to research and understand the laws, rules, and customs of the country does business.
There is a simpler and faster way.
If you don’t have the time to understand the cultural, political, rules, and laws that govern doing business in a foreign country but you still want to expand into that country and you have a team all ready to go, trust Globalization Partners.
Through our Global PEO and Employer of Record model, we combine first-rate international HR and legal expertise. We use our in-house infrastructure to help companies hire teams in over 170 countries without having to first set up a subsidiary or branch office.
If you would like to find out more about what we can do for your company in a foreign market, request a proposal or contact us. A member of our experienced and knowledgeable team will get back to you as quickly as possible.
For more information on how to successfully expand your business internationally and an overview of the correct steps involved, be sure to read our guide on How to Scale Globally Without Sinking, viewable here: