Putting a Stake in the Ground: Launching a Branch or Subsidiary in a Foreign Market

While trade garners the headlines, direct investment by companies or nationals of one country in assets or free-standing companies in another country is a much more significant part of the international economy. It is also much more important for companies–the commitment in money, time and risk is much more material than deciding simply to export products to a foreign market. A cross-border investment, whether a new green field project or acquisition, involves a whole host of decisions. The first is whether to serve a foreign market. For many companies, the local market is sufficient; and, as long as it is growing, they are happy to stay focused on that market. For other companies, once they have achieved a certain level of sales in the domestic market, whether in terms of total sales or market share, they must look to other markets for continued growth. In some cases, the other markets can be new products. In many cases, other markets can only mean new geographical ones. While both new product and new territorial markets pose advantages and risks, the choice often depends on where a company feels its competitive advantage lies. The wider its core competency, the more likely it is to expand into new products. The narrower it feels its competencies are, the more likely it is to take that narrow product skill into new geographical markets.

Once a company decides to enter a new geographical market, it is likely initially to serve the market in one of the ways described in other chapters–direct sales through exporting, indirect sales through local sales agents or distributors, or franchising. After awhile, if it discovers sufficient demand or believes it exists, the company is likely to decide to set up its own physical presence in the foreign country through direct investment. There are several common methods that may be used for direct investment. In a new chapter added this month to Business Transactions Solutions on WESTLAW (§§ 283:1 et seq.), we discuss the use and operation of a branch office or facility, sometimes referred to as a permanent establishment, in a foreign country and the creation of a wholly or majority-owned foreign subsidiary, sometimes referred to as a central enterprise. While the primary focus of the discussion in the chapter is the formation and organization of a new branch or subsidiary, it is possible to take over an existing operation in a branch or subsidiary structure through acquisition or merger.

When planning for the formation, organization and operation of foreign branches or subsidiaries, it is important to remember that the branch or subsidiary will ultimately need to perform many of the functional activities associated with any business. The range of activities, as well as the timing for introducing a specific activity, will depend on the strategic purpose of the branch or subsidiary. For example, if a branch is established exclusively to launch direct sales activities in the foreign country, then it is obvious that the initial investment should focus on those areas that support sales–recruitment of sales personnel, development of marketing and advertising campaigns, and customer support. Other functional areas, such as new product development and manufacturing, will continue to be handled at the headquarters level until the decision is made to establish those capabilities in the foreign country. However, even if the activities are limited to a single function, the branch or subsidiary will still need to establish procedures to satisfy accounting and financial requirements; locate suitable facilities and negotiate real property purchase and lease agreements; purchase and lease equipment and other personal property for the business; obtain insurance covering its activities; implement legal compliance programs; and establish management guidelines and human resources policies and procedures to recruit and retain qualified personnel.

Financing the new legal operation is obviously an important issue and many parent companies set up a simple form of loan facility agreement through which the new foreign subsidiary can easily obtain financial support from the parent in order for the subsidiary to conduct various operational activities.  The subsidiary may have been formed and organized by the parent or it may be an established company in the foreign country that was acquired by the parent with the intent that it continue to operate as part of the parent’s global network of businesses. While the subsidiary may attempt to obtain a term loan and/or revolving line of credit on its own from a local financial institution it may be easier to set up an inter-company loan facility that the subsidiary can use without having to abide by the restrictive covenants that will inevitably be imposed by outside lenders.

The specialty forms library in the new chapter includes a management services agreement, a consulting agreement for management of European subsidiaries, a services and royalty agreement, a general assignment and assumption agreement and intercompany loan facility for a foreign subsidiary. The chapter also includes a checklist of matters to consider when forming a foreign branch or subsidiary, a checklist for managing a global subsidiary governance framework, executive summaries for clients regarding ways of doing business in foreign markets and forming and organizing foreign branches and subsidiaries, and a slide deck presentation on forming foreign branches and subsidiaries.  Related issues are covered in the chapters on Launching and Managing Global Business Activities (§§ 259:1 et seq.), Evaluating Foreign Markets (§§ 260:1 et seq.), Developing an International Business Plan (§§ 261:1 et seq.), International Sales of Goods (§§ 274:1 et seq.) and Cross-Border Investments (§§ 286:1 et seq.).

Want to learn even more?  Sign up for the webinar on “Helping Your Clients Launch a Foreign Branch or Subsidiary” being presented by West Legal Ed Center and the Business Counselor Institute on Tuesday, December 13th at 11:00 AM Central Time.  Follow this link for registration information.  It’s the fourth and last part of a series on Going Global to help you be better prepared for client questions on growing their businesses in foreign countries.  You can learn more about the series here.

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