Globalisation has rewritten the playbook for business success. Organizations can now transcend national borders and explore opportunities in foreign countries — they can tap into new markets, access a diverse talent pool, and unlock explosive growth. 73% of CEOs believe global expansion is critical to their company's long-term success, according to a 2023 PwC report. But how do you navigate this vast ocean of opportunity? One powerful strategy is establishing a foreign subsidiary, a venture that can propel your company to new heights but presents its own challenges.

What is a Foreign Subsidiary?

A foreign subsidiary is a distinct legal entity established and operating in a country outside the parent company's home base. It has its own management, financials, and legal obligations while remaining under the strategic control of the parent company. This intricate relationship involves knowledge transfer, resource sharing, and careful orchestration to ensure both entities flourish.

Difference Between Foreign Subsidiaries and Other Business Entities

It's easy to confuse a foreign subsidiary with terms like foreign branch, permanent establishment, or affiliate. However, the key difference lies in the level of control and legal independence.

Foreign subsidiary vs. Foreign branch

A foreign subsidiary is a full-fledged, separate company located in another country, much like a mature tree thriving on its roots. The parent company may offer guidance and resources, but the subsidiary operates independently, with its own management, staff, and legal framework.

On the other hand, foreign branches are extensions of the parent company operating in another country, like branches sprouting from the same tree trunk. They share the same name, resources, and legal identity as the parent company, which fully controls the branch’s activities.

Foreign Subsidiary vs. Permanent Establishments

Permanent establishments are fixed places of business in foreign countries where the parent company conducts significant operations. They are liable to pay local taxes on revenue generated within the foreign country. However, they're not separate legal entities like foreign subsidiaries. Imagine setting up a temporary production facility in another country — that's a permanent establishment.

Foreign subsidiary vs. Affiliate

Affiliates are similar to subsidiaries but are like close cousins rather than direct offspring. The parent company of an affiliate holds a minority ownership stake in the company (less than 50%) while the parent company of a foreign subsidiary holds a majority ownership stake (more than 50%).

Benefits of Establishing a Foreign Subsidiary

Foreign subsidiaries act as powerful launchpads for companies looking to expand globally. They enable companies to tap into new markets, reach more customers, and drive organic growth. Below are more benefits that foreign subsidiaries offer:

Operational Flexibility

Adapting to local regulations, optimizing production costs, and accessing skilled talent pools.

Strategic Control

Leveraging tax benefits, mitigating risk for the parent company, and exploring strategic investment opportunities.

Workload Diversification

Optimizes efficiency by offloading production, distribution, or customer service tasks.

Trust & Credibility

For establishing a local presence to foster consumer trust and brand loyalty, especially in culturally sensitive markets.

But every rose has its thorns.

Cons of Establishing a Foreign Subsidiary

While the benefits of expanding into new markets are undeniable, establishing a successful & separate legal entity abroad has several drawbacks that deserve careful consideration before entering uncharted territory, such as

Upfront Investment & Ongoing Costs

Setting up and running a Foreign Subsidiary involves significant capital expenditure and ongoing operational costs.

For example, you may need to pay for

Legal and accounting services.
Office space, equipment, and licenses.
Hiring and training local staff.
Rent, utilities, and payroll.

Operational Complexity & Risks

Operating in a foreign country means you’ll have to grapple with complexity and risks, such as

Unfamiliar legal and regulatory frameworks impacting employment, taxation, and business practices.
Cultural differences that may affect communication, decision-making, and business etiquette.
Potential political instability or economic slowdowns in the host country.
Supply chain disruptions due to logistics challenges, infrastructure gaps, or trade barriers.

Communication Challenges

Establishing a foreign subsidiary requires communicating across different countries and cultures. However, time zone differences may hinder real-time communication and collaboration. Additionally, communicating in different languages could lead to confusion and misunderstanding, especially when dealing with complex or technical issues. Effective communication and coordination between the parent company and the subsidiary will require robust systems and cultural sensitivity.

Difficult to Dissolve

Winding down a subsidiary can be lengthy and arduous, requiring careful planning. In addition to legal and regulatory hurdles, you may suffer financial losses from asset disposal and employee severance packages. You also risk hurting your brand reputation if the closure is handled poorly.

Should You Open a Foreign Subsidiary?

Deciding whether a foreign subsidiary is the right step for your company requires careful consideration of several factors. Consider asking questions like:

Is the target market large enough and growing fast enough to justify the investment?
Can you realistically project a healthy Return on Investment (ROI) over the long term?
Does the legal and regulatory framework in the target country support your business model?
Do you have the internal resources and expertise to manage a foreign operation?
Are you prepared to navigate the risks and costs of compliance in a new market?

In addition to exploring these, it is good to consider alternatives to setting up a Foreign Subsidiary that also aligns with your global expansion strategy.

Foreign Subsidiary Alternatives: Employer of Record (EOR) Solutions

The good news is you don't have to choose between embracing global opportunities and navigating the hurdles of a foreign subsidiary. One of the most viable solutions you can opt for to overcome the complexities is an Employer of Record (EOR). An EOR is a service provider that acts as the legal employer for your employees in a foreign location.

Benefits of Choosing EOR as an Alternative to Foreign Subsidiary

Low-Risk Entry: EORs are responsible for navigating legal and administrative complexities, allowing you to enter new markets with minimal upfront investment and risk.
Higher Adaptability: An EOR enables you to respond swiftly to market fluctuations by scaling your operations up or down. You can hire talent for short-term projects or adjust team size efficiently without the burden of setting up a separate entity.
Faster Onboarding: An EOR enables you to bypass the lengthy onboarding cycles and bureaucracy associated with hiring abroad. You can access qualified talent and onboard new employees in days, not months, ensuring that critical roles are filled quickly.
Access to Global Talent Pool: EORs source and manage talent in any location, connecting you with the best minds regardless of their geographical location.
Reduced Costs & Complexity: Partnering with an EOR eliminates the overhead of payroll, taxes, and benefits administration in different countries. EORs cover all legal and administrative burdens, allowing you to scale easily and focus on core business growth.
Peace of Mind: Maintain compliance with local labor laws and regulations. EORs assume all legal and financial responsibility for your employees, giving you complete peace of mind while expanding internationally.

Choose an EOR if:

You need fast, flexible entry into a new market.
Your project or resource needs are temporary or fluctuate significantly.
You have a limited budget or risk tolerance for setting up a subsidiary.
You prioritize agility and scalability over complete operational control.

The Final Word: Expand Wisely

Whether you choose a foreign subsidiary or an EOR, the key is approaching global expansion with a well-defined strategy and meticulous planning. Carefully assess your goals, resources, and risk tolerance before leaping into it. Remember, both options offer unique advantages and drawbacks, and the optimal choice depends on your specific business needs and ambitions.

So, map out your global aspirations, weigh your options, and leverage the power of foreign expansion to propel your business to new heights.

Contact our experts at Gloroots for a personalized consultation to discuss your global business needs.

Remember, expanding your horizons doesn't have to be a daunting task. With the right knowledge and partners, you can unlock the incredible potential beyond your borders.

What Is a Foreign Subsidiary? When Should You Choose It?