An important decision that companies often ask when starting a company outside of the USA is ‘where should I incorporate?’.
The reason why this question comes up is often because there are a series of benefits pulling founders in different directions and many times founders can receive conflicted advice from well-intending advisors. Some of the issues that founders may be balancing as part of a decision on where to incorporate include things like tax implications (tax breaks or penalties), local grants, and paperwork. This is particularly the case when they are also thinking that the USA might be where they will end up in the future.
Therefore, the purpose of this post is to identify WHAT ISSUES to think about when making the decision so that you can feel more confident about it and it is NOT about recommending a specific jurisdiction to incorporate.
Let’s start by stating that, for the most part, incorporation decisions aren’t necessarily permanent. Yes, there are cases where you make things increasingly hard for you to ‘flip’ your company (flip = taking your company from one legal jurisdiction to another), but for the most part, you can almost always find a way to move your company later if it benefits you to do so. Generally, the cost of doing this will be proportional to the complexity and legal jujitsu your lawyers will have to do in order to make this happen (more on this later). So while not permanent, worth considering all options before taking the easiest or most obvious choice.
Now that you perhaps feel a bit more ‘relieved’ about the not-so-permanent nature of your decision, let’s look at some key factors to consider which will affect your decisions down the road:
1) Tax implications & Tax treaties – One of the key things that can really impact your personal returns and that of your investors, now and in the future, is whether there will be a tax impact to you (and your employees and co-founders). Consider things such as tax relief on returns as a founder or if you flip to a different geography in the future. Consider income tax liabilities as well as capital gains liabilities (note: links are to UK site, but there for definitions, which are universal). Additionally, for potential future investors, consider whether your local jurisdiction has a negative tax impact further down the line for them. These questions can sometimes be answered by tax specialists within your lawyer’s firm (particularly if your law firm has offices abroad) or your accountants.
2) Investor implications – As mentioned above, one reason why the jurisdiction of choice matters is because investors are optimising around what they know their tax implications are, but additionally, there are other matters in the final legal docs which they may prefer dealing with in their local jurisdiction rather than in new ones they are less familiar with. Additionally, they may have a preference where you incorporate due to tax relief they may receive as part of investing in your company. Company governance may also be affected by where you are incorporated. Certain company governance structures are enforced on your company depending on where you incorporate and investors may have an opinion on that one way or another.
3) Paperwork implications – Paperwork is clearly one of the bigger headaches of making this decision. This includes the interval in which you need to report as well as other requirements such as company filings required by Company’s Law of the country where you incorporate.
4) Residency implications – Some geographies may have a residency requirement for the founders, but others not. Keep this in mind, in particular if you don’t have the appropriate immigration status or it is hard to get it.
5) Human Resources implications – In some countries it may be harder for your employees to move to if necessary, and/or hiring may also be a problem because of lack of human capital or cost to hire and retain. Additionally, there may be restrictions on how you can hire / fire employees that might affect how you upscale / downscale your company’s employees. João Abiul Menano of CrowdProcess also suggests: “One should also considered tax over labor, in some cases a tax incentive given to an early stage start-up can largely help to keep the burn rate low (more important even for companies in which labor costs account between 70% and 90% of monthly expenses)”
6) Governance implications – Corporate Governance requirements tends to vary from country to country. Since you’ll have to abide some of these requirements, you might as well familiarize yourself with these variables before making your decision.
7) M&A implications – When your company does eventually get sold or merged or floated, it’ll have to go through a process. In some countries this process is straight forward and simple and easy for potential acquirers to understand and do quickly. In other countries, it may be less known and thus may cause delays or complications.
8) Free Information Availability – Although you will likely have a Lawyer helping you through many of these topics, it’s always great when you can learn on your own from others’ experiences. Some jurisdictions have more founders sharing on forums and the like, how they overcame their specific problems. This can be a very valuable way of reducing your cost to learn and thus reducing your legal costs as you know which issues to flag to your lawyers.
Having reviewed all of these issues with your current and/or future shareholders, you should at least have a better starting point to make a well thought-out decision.To further elaborate on these topics, and to be more specific about one particularly common case for UK founders, let’s look at UK vs US incorporation.
UK Pros –
· Simple to set up
· Good for companies with international investor base – The UK is one of the most friendly of the European jurisdictions
· SEIS/EIS tax relief for investors may be available for your company – helps more investors take an interest in investing in early stage
· EMI (for employees) may be available – helps to attract talented staff
US Pros –
· Well-developed template documents for seed investment (lowers legal cost)
· Lighter touch, more founder friendly
· Simpler mechanisms to issue shares (except for US securities laws)
· Document execution streamlined – can be easier than the UK at times
· Privacy – company information (board, shareholders) and financial information not publicly available for private companies
· Large and seasoned US investor base
· Can sell easily to US buyer via merger mechanism
UK Cons –
· Many US investors will not invest in foreign entities (even if the UK is probably the best 2nd option if International)
· Information about the company (board, shareholders) and financial information publicly available (in some circles, this is seen as a pro….)
· Depending on investors funding rounds can be over-complicated – not all investors are familiar with using the streamlined forms that are readily available
· If you have US investors that are funds, you may be required to give tax covenants/indemnities
· Merger mechanism may not be possible if there is a sale to a US buyer, so exits may be more complicated
· A US listing may be more complicated
US Cons –
· Can be expensive, especially if there is no business in the US
· May not be as easy or as tax efficient to operate in Europe through a branch
· Possibly inefficient tax-wise if not generating major revenue in the US
· US Securities Laws are more complicated
· Filings required with the US Department of Commerce
· SEIS/EIS and EMI may not be available
While this decision is clearly not a black and white one, hopefully, the 8 factors to consider before incorporating highlighted above + the UK vs US example help you better understand how to approach making this decision for your specific case and which questions to ask your lawyers. It may very well be that there are some similarities between the above two countries and your own, but the best way to finalise this decision is by having a conversation with your lawyers about what is best for you, your investors and the jurisdictions in question.
If you have any additional points for founders to consider as they go through this process, feel free to post them in the comments below. Additionally, if you have any feedback on the points above or have a good story to tell about your experience through this process, feel free to post as well.