Expanding internationally, going remote-first, facing skill shortages in the home country… There are many different reasons why businesses might need to hire international employees, and also different ways to get there.
The two main approaches to hiring abroad are setting up a legal entity and using an Employer of Record. But how to decide which option to go for? When should businesses use an EOR? And when should they open up a legal entity?
In order to decide between an Employer of Record solution and legal entity set-up, businesses need to first understand the fundamental differences between the two approaches.
An Employer of Record (EOR) enables businesses to hire employees abroad without having to set up a legal entity in the respective market. This is made possible through the fact that the EOR provider becomes the employee’s legal employer and takes over the full legal liability.
As a third party, the Employer of Record takes care of:
Compliance: local labor law and other regulations, employment contracts, and more
Payroll and taxes: tax registration, processing of all the necessary withholdings and deductions, payments, and more
Local benefit administration: compliant and attractive benefit packages, registration with local pension funds, health insurance etc.
Termination: managing the separation process according to local standards
Using an EOR is a quick and cost-effective solution for expanding businesses because it allows them to explore new markets without having to commit to them straightaway. However, the EOR model has its limits. In cases where Employer of Record is not an option, the organization usually has no choice but to establish its own entity.
Establishing a legal entity is the traditional approach to hiring employees in new markets. There are different types of legal entities, with representative offices, branch offices and subsidiaries being the most common ones:
Subsidiary: fully operational legal entity that is partly owned but otherwise independent from the parent company which is hence protected from legal liabilities triggered by the daughter company
Branch office: foreign office of an organization through which the latter conducts business in another market; no separate legal entity, which means that the parent organization headquartered in another country carries the full legal liability
Representative office: minimal presence of an organization in a country where it is not fully incorporated; limited to business activities linked to representation
Deciding whether to use an Employer of Record or create a legal entity requires a firm understanding of the pros and cons of both approaches. Here are the main reasons why expanding businesses decide to go with an Employer of Record—or decide to incorporate.
The main benefits of hiring international employees through an Employer of Record are:
No need to incorporate, which saves time and money
No need to worry about compliance, local labor laws, payroll, taxes, or employee benefits
More time and resources to focus on core business activities
Greater flexibility and easy exit option when testing new markets
Local expertise and ongoing compliance support
Simultaneous expansion into several markets possible
Despite being the far easier option, the Employer of Record model also has some drawbacks, notably:
No protection from permanent establishment (PE) risk
Need to coordinate and manage several EOR partners
Extensive research required to choose a good provider
Time limits imposed by certain countries (e. g. limited to 18 months in Germany under AUG)
Limited number of employees (linked to PE risk)
Legal gray area in some countries
Potential negative impact on employee perception and sense of belonging
Before deciding to establish a legal entity, businesses should carefully weigh the pros and cons. On the plus side, opening a separate legal entity in the new market allows the business to:
Be fully operational
Engage in any business activities without having to worry about triggering unwanted tax liabilities
Have legal clarity
Establish a proper presence and increase visibility in a new market
Not have to pay a monthly service fee to an external third-party provider
However, the downside is that establishing a separate legal entity:
Takes a lot of time and resources
Entails a complicated incorporation process
Requires substantial upfront investments and capital requirements
Cannot be done without profound knowledge of local laws and regulations
Means that the entire legal liability is on the expanding business
Since both EOR and legal entity set-up have their merits and drawbacks, there is no clear-cut answer as to which of the two is the better option. Instead, this decision must be made based on the individual circumstances:
To test a new market before fully committing to it
To enter a new market quickly
To bridge the gap between entering a new market and having a fully operational entity
To recruit specific talent that is not available in their home market
To scale a global team and hire in different locations simultaneously
More information on EOR use cases: Why and when to use an Employer of Record?
Creating legal entities to drive global expansion is a good option for businesses that:
Want full access to new markets for their products and services
Are looking for a way to enhance business growth
Want to set up a cost-effective production
Are striving for worldwide brand recognition
Want to be able to compete in the new market
In addition to the general use cases for both approaches, the following questions can be used to point expanding businesses in the right direction:
Is the presence in the market only temporary or is it a long-term project?
How many employees will be needed?
Is there a need to have an office to receive clients and business partners?
How many markets are on the business expansion roadmap?
Which activities will the organization and employees engage in?
Is the business ready to fully commit to the new market(s)?
Does the organization have internal knowledge regarding local labor laws and other compliance issues?
Are there any qualified executives at hand who could act as local directors (if appointing local directors is required by law)?
Is the organization pressed for time (e. g. to keep up competitors)?
When it comes to global expansion, there is no one-size-fits-all solution. Whether it’s better to establish a legal entity or hire through an EOR largely depends on the scale and timeline of the expansion project and the business’s knowledge regarding the local legal landscape.
Cases where it is advisable to contract an Employer of Record include: little experience managing foreign operations and restricted knowledge of the new market; need to expand fast and without capital requirements; parallel expansion into several foreign markets; and need to test the new market before taking any further steps.
In some cases, however, setting up a legal entity is worth the extra time, money, and effort. Some of the advantages of being properly incorporated are: cost-effective manufacturing options; increased worldwide brand recognition; full access to a new market; better legal clarity.
The Lano Academy is for informational purposes only and should not be construed as legal advice. Lano Software GmbH disclaims any liability for any actions you take or refrain from taking based on the content contained in this article.
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