U.S. Market Entry – Legal Structures for Foreign Startups

In my last blog concerning market entry into Silicon Valley by foreign companies, I discussed some of the basic issues and tasks surrounding the effort. As an attorney practicing corporate law and representing technology startup companies, I am often asked to assist in designing and implementing the legal structures that enable a foreign-owned company to access the US market.

There are a number of factors that guide a company’s decision to enter the US market. First, what is it trying to sell? Second, does the company hope to generate its return on investment through a cash-flow from sales, or by building value and ultimately selling the company or taking it public? Third, does it need funding from US private investors? Let’s look at how each of these factors guide entity form.

The first factor focuses on the best method for product distribution. If the company is trying to sell simple, commodity type products using an established distribution network, it may be able to get by with no entity at all. In other words, it can sell its products directly into the US through a distributor or independent sales representative. Even if the product is complex, but does not require a sophisticated domestic marketing, sales, or support organization, an independent sales representative could be used.

Where the product requires more than a sales representative to adequately exploit the US market, the company will need to consider forming some kind of entity. This is where the second factor comes in.

If the foreign company only wants its US company to generate sales and build up revenues for possible distribution to the parent company, and does not expect to use profits to drive expansion, it should explore forming the US company as a pass through entity, such as a limited liability company or partnership. Subject to certain exceptions, this will allow the US entity to avoid income taxes at the entity level. The extent of the overall tax burden, however, to the company as a group will need to be explored with an international tax professional.

If, on the other hand, the US company is expected, among other things, to grow on its own, secure outside funding, or be sold to another company, then a corporation is the preferred entity. A corporation, particularly if incorporated in Delaware, is a well-recognized method of doing business and can be created and organized easily. The US company will also be able to use operational profits to grow without the phantom income issues associated with pass through entities, and can avail its stockholder of beneficial tax treatment if it is later acquired.

Foreign startup companies often outgrow their home market, and look to the US, particularly Silicon Valley, as a beachhead into the US. This is where the third factor comes in. Many of these companies have built their technology, and have generated sales that validate the market for their products. They are stymied in their home countries, however, by the lack of expansion capital and become attracted to the established and sophisticated private investor market in the US. Knowing that investors prefer to invest locally, foreign startup companies soon realize they must relocate their headquarters to the US. The process by which they accomplish this is often referred to as a “flip-up”, and will be the subject of a subsequent blog.

Analyzing basic distribution, return on investment, and funding requirements is necessary to determine the best approach to entering the US market.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific Questions relating to this article should be addressed directly to the author.