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Don Durfee, CFO Magazine
The pleasures and perils of taking a local business global.
Nearly
35 years after China reestablished trade with the United
States, launching a foreign subsidiary there remains difficult — especially
for a smaller company. Managers must come up with a business
plan, translate it into Mandarin, then submit it along
with a two-inch pile of forms. That’s when the real work
begins, with seemingly endless revisions and negotiations
with Chinese officials. From start to finish, the process
can take two years.
Even
then, a foreign operation needs a Chinese name before
it can begin to conduct business. When The Hoffman
Agency, a Silicon Valley public relations firm, reached
that point, CFO Leon Hunt was told he had to come
up with six possible DBAs to submit to officials
in China. Hunt says he could barely come up with
four that captured the mission of his company. Still,
the form had to be completed, so he picked the last
two names arbitrarily. “Our attorneys said not to
worry,” recalls Hunt. “They said we’d get our first
or second choice.”
The
PR firm got its sixth choice. The name translated
roughly as “Good Fortune Consulting Co.” — an
auspicious title, perhaps, but one better suited
for a local tea-leaf reader than a global public
relations firm. In the end, The Hoffman Agency managed
to secure its first choice (which loosely translates
as Hoffman Business Consulting), but not without
some scrambling.
Managers
at many small-to-midsize businesses can relate. Consultants
say they’ve seen a flood of smaller companies rushing overseas
over the past two years. Some of the risk-takers are lured
by burgeoning consumer markets in big countries like China,
India, and Russia. Some are looking to set up cheaper production
facilities in emerging markets. Others are simply following
clients overseas to major European cities.
Most
are going sooner than they would have 10 years ago. Indeed,
many small businesses are expanding internationally before
they’ve even established a solid base of operations in
their home markets. “You used to see venture-backed companies
going abroad after their C or D round of funding,” notes
Larry Harding, founder and president of High Street Partners,
a consultancy that helps companies manage their international
finances. “Now they go abroad during the A round.”
Many
are unprepared for what awaits them. Operating in several
markets across a number of time zones presents operational
challenges. Tax codes may be convoluted. Quirks in local
employment laws can prove baffling for inexperienced managers,
landing their fledgling operations in legal hot water.
Fluctuations in exchange rates can foul up even the most
modest revenue forecasts. Emerging markets remain particularly
risky for small companies, which can’t always afford the
high-powered lawyers employed by the Fortune 500.
The
risk takes a toll. According to a recent study by Bain & Co.,
only a third of expansions overseas by U.S. retailers have
returned their cost of capital. “People are naturally enticed
by growth,” cautions Ron Langford, managing partner at
consulting firm Marakon Associates. “But they’re spending
less time thinking about the bottom-line implications of
their decisions.”
Contract First, Office Second
Bruce Ferber can attest to that. Ferber, now CFO at Herndon, Virginia-based
consulting firm Digital Focus, was involved in overseas expansions with two
previous employers. Neither fared particularly well.
At
one, a division of General Electric called GE Capital Spacenet,
managers spent millions of pesos building a satellite ground-services
operation in Argentina. Customers were less than enthusiastic.
Eventually, GE Capital spun off the struggling division. “‘Build
it and they will come’ is way too risky from my perspective,” says
Ferber.
Instead,
the Digital Focus CFO prefers a less starry-eyed approach.
He advises small-business executives to sew up a contract
in a foreign country before setting up a local office.
Ferber stuck to that belief when management at Digital
Focus began contemplating its own move overseas last year.
The
planned expansion wasn’t optional. Digital Focus had recorded
revenue growth of 300 percent in 2003. But business at
the technology consulting firm slowed dramatically the
next year, with revenues up just 30 percent. Boosting sales
meant opening in new markets. It wasn’t hard to decide
which ones. European countries are deregulating their national
telecommunications companies. Such a bust-up usually means
technology chaos and big IT budgets — a good combination
for tech advisers like Digital Focus. With this opportunity
before them, the company’s managers okayed a scheme to
set up an operation in London.
This
time, however, Ferber was determined to match costs more
closely to revenues — and London isn’t cheap. “The
prices in London and New York are pretty much the same,” he
says. “Just put a pound sign in front of the number instead
of a dollar sign.” Rather than committing to an expensive
lease and hiring a local salesperson, the company first
sent president Erin Smith to the UK to drum up business.
After a sales meeting and a few phone calls, Smith landed
Digital Focus’s first overseas contract. The consulting
firm’s team worked out of client conference rooms, hotel
lobbies, and local coffee shops.
The
cost-conscious approach helped the company turn a healthy
profit in 2005. Digital Focus is using the revenues from
the initial engagement to fund further operations in the
UK, including, finally, the lease of an office in London.
While that workplace is three times as expensive as the
consultancy’s space in Herndon, the London office isn’t
exactly the equivalent of a Park Avenue suite. “We could
have gone someplace [fancy] like Covent Garden, but we
wanted to reinvest our profits,” explains Smith. “There
are coffee stains on the rugs, but our clients like that.
They say, ‘At least we’re not overpaying you.’”
No Net, and Loving It
For those courting clients, not overpaying is crucial, particularly in the
early days of a cross-border expansion. As Marakon’s Langford points out, “Companies
that are the most successful with their expansions are often the ones that
can be profitable early.”
That’s
easier said than done. Setting up cross-border operations
can strain a finance chief’s ability to control administrative
costs. CFOs accustomed to dealing with one set of books
and one set of federal tax codes suddenly find themselves
dealing with several general ledgers and multiple tax regimes.
Differences in accounting treatments only add to the complexity.
For
larger operations, the answer is simple: hire more finance
staff to master local issues and support each business
location. A start-up with five overseas sales offices can’t
afford that, however. Neither can managers at resource-strapped
small-cap companies. “You want good data from your country
offices,” acknowledges Stu Fuhlendorf, CFO of Isilon Systems,
a manufacturer of clustered storage systems. “But you don’t
want a huge international infrastructure, especially when
you already have the burden of Sarbanes-Oxley.”
To
some extent, advances in technology are easing the pain. “Ten
years ago, you had to have someone in every country to
create and load a payroll tape,”says Bob Cecil at EquaTerra
Inc., an outsource and insource advisory firm. “With self
service and the Internet, you don’t need that anymore.”
Letting
someone else do the legwork is another option. Consider
Isilon’s arrangement. The Seattle-based company has offices
in Tokyo, Seoul, London, and across continental Europe,
yet it has no permanent finance staff in any of those spots.
Instead, Isilon management hired High Street Partners to
help it line up local accounting firms in each market.
Every month, High Street collects the numbers from the
firms, reviews the figures for accuracy and consistency,
and then passes the data along to its client. This allows
Isilon to tap into local expertise without incurring big
fixed costs. “We are ramping up very quickly, and this
makes it easier for us to get into new countries,” says
controller Pearl Chan. “And if we have to ramp down, we
can do that, too.”
The
arrangement is helpful, given that the business-process-outsourcing
industry hasn’t quite caught up with the needs of smaller
global companies. Large BPO specialists generally focus
on more-profitable accounts, meaning large corporations.
And while finance-outsourcing boutiques such as Core3,
Outsource Partners International, and Savista (owned by
Accenture) do offer some overseas services, they tend to
stick to certain countries or industries. Savista, for
example, serves small-to-midsize companies in the restaurant
business.
Even
with outside help, international business is undeniably
harder on finance at smaller outfits. “Having overseas
subsidiaries means doing more with the same resources,” says
Don Pratt, CFO of Ellacoya Networks Inc., which makes hardware
and software to control broadband networks. “We effectively
have a 24-hour workday. If you need to talk with someone
at 9 or 10 at night, you just need to do it.”
Of
course, executives at some small companies say they welcome
the challenge of going global without the reassuring infrastructure
and resources of a big multinational. That appears to be
true for Bruce Ferber. “As a former GE Capital finance
guy, I’ve played in the international space before,” he
says. “But this time I’m working without a net. It’s exhilarating.”
Shortcut This Way
With
or without a net, flops happen. Before venturing into
China, The Hoffman Agency tried to crack the Japanese
market. Taken aback by the country’s high prices, CEO
Lou Hoffman came up with what seemed like a bright
idea: he hired a consultant to help him find a local
Japanese partner who could share office space and help
sell his company’s PR services in Japan. “I was feeling proud for being so clever,” says
Hoffman. “But it was a disaster.”
Hoffman’s
partner was a Japanese-English translation service
with three employees. As it turned out, the local
partner was neither interested in learning the high-tech
PR business nor able to win much new business. There
was a cultural problem, too: many Japanese executives
are reluctant to do business with companies that
aren’t incorporated in Japan. “We
came across as second-class citizens,” recounts Hoffman.
After two years without progress, Hoffman canceled
the partnership and started again.
Better
planning may have prevented the problem. As Michael Collins,
a partner with Bain, points out, “You need to realize that
the right time to start looking at expansion is long before
you need it to hit your top and bottom line.” Businesses
don’t always have that luxury, however. When Security Innovation
yielded to its customers’ requests that it open an office
in Europe, managers at the Wilmington, Massachusetts-based
software security company moved quickly, taking just three
months to make the arrangements. “It wasn’t enough time,” concedes
CEO Edward Adams.
If
he had greater advance notice, Adams probably would have
boned up on Dutch employment laws. The CEO notes that he
granted one new hire in Amsterdam a lifetime contract (which
is what the employee had at his previous job) without understanding
the contract’s binding nature. “There’s essentially no
concept of at-will employment,” explains Adams, who is
now more familiar with work rules in the Netherlands. “I
didn’t fully grasp that. It has the potential to be a substantial
liability for the company.”
That’s a misstep Adams won’t make again. Likewise, Hoffman
says the unpleasantness in Japan helped him when he
began mapping out the company’s China strategy. Rather
than rush things, the company recruited a skilled communications
executive from China’s petroleum industry and brought
her back to the company’s Silicon Valley office for
18 months to learn the company’s business. Then and
only then did the agency send her back to open an office
in Beijing. “A year and a half seemed like an eternity,” Hoffman
concedes. But he says the “disaster” in Tokyo taught
him a valuable lesson. “I learned that if something
looks like a shortcut, it probably isn’t.”
Patience has paid off.
The Hoffman Agency’s unit in Beijing has grown to 14
people and is now the company’s fastest-growing operation.
Don Durfee is research editor at CFO.
Software Without Borders
Small
businesses may be venturing abroad in large numbers, but
you’d never know it by the lack of software titles available
for managers at those companies. Sage Accpac ERP, for example,
is a fully featured, Web-based resource-planning program,
but the software is targeted at international companies
with at least 100 employees. That leaves a lot of undersized
companies out in the cold.
Leon
Hunt ran into this problem in 2002 when he was
setting up an infrastructure for The Hoffman Agency’s
overseas operations. Hunt, CFO at the Silicon Valley–based
public relations firm, says he couldn’t find any accounting
or time-and-billing software packages that fit his requirements.
ERP packages from the likes of SAP and Oracle were too
expensive, and scaled-down packages didn’t include essential
features such as currency conversion. Ultimately, Hunt
kept his Peachtree accounting system (from Sage Software). “We
just had to do the translations manually,” he laments.
Even
today, the Peachtree program, which is aimed at companies
with 5 to 50 employees, lacks features for conducting
cross-border business, such as multiple-language capability.
Paul Hamerman, vice president, enterprise applications,
with Forrester Research, says good finance programs do
exist for slightly bigger companies, including packages
from Microsoft Dynamics NAV, Exact Software, and the Sage
Accpac application. Those products offer a full range of
international business functions and, surprisingly, don’t
cost a fortune. Hamerman estimates that the software will
run a small company between $10,000 and $25,000. A caveat:
the programs are mostly one-off solutions that are difficult
to deploy over a wide-area or location-by-location network.
Says Hamerman: “You have
to transfer the data into a consolidation package, or,
God forbid, Excel.” — D.D.
The Tax Trap
Finance
managers who think global tax planning means mastering
foreign tax codes may be peering through the wrong end
of the telescope. Tax experts say the biggest tax traps
for U.S. businesses with international operations often
lie in their own backyards. That’s because the United States,
unlike many countries, taxes its citizens on the money
they make around the world, not just at home. Here are
a few of the snares, courtesy of Uncle Sam:
Those Darned Forms.
International
business brings a ton of paperwork, both from the Internal
Revenue Service and the states. Examples: IRS form 5471 (ownership
of a foreign corporation) and U.S. Treasury form TD90.22-1
(overseas bank accounts worth more than $10,000). Failure to
file these forms — or just plain getting them wrong — can
trigger fines ranging from $10,000 to $100,000 and possible
criminal penalties. BDO Seidman tax partner Shawn Carson says
filing problems often arise when small businesses turn to local
tax firms with little experience in international tax compliance.
Pay and Pay Again.
When
setting up the legal structure of an overseas business, companies
often choose pass-through entities such as partnerships or
S corporations. Done right, these setups provide a nifty shelter,
with the parent company paying only U.S. tax on the foreign
income. Get it wrong, though, and troubles abound. A U.S. partnership
that creates a Canadian subsidiary, for instance, may well
end up paying a dividend tax in the United States and a corporate
tax in Canada — without the benefit of a foreign tax
credit offset.
DIY Transfer Pricing.
U.S.
companies with multiple overseas operations often conduct sales
between those businesses to help shift profits to lower tax
regimes. Advisers exist to help companies set up the schemes,
but the service can be expensive (full reports can cost as
much as $40,000). Doing it yourself can be tricky, though.
Tax experts say managers often set prices too high or too low. “I’ve
seen some small companies do it on their own without a problem,” says
Carson. "But I’ve seen others that have run into all sorts
of problems with the tax authorities." — D.D
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