“The Blind Men and the Elephant” is a classic Indian folktale in which six blind men who long to learn about life outside of their small village discover an elephant for the first time, with a surprising connection to cross-border carve-outs. As each man inspects the elephant, he describes what he perceives the animal to be. For example, the man who touches the trunk decides it is like a snake. Meanwhile, the man who touches the tusk declares that the elephant is as dangerous as a spear.
All told, none of the men can accurately describe the elephant because none can see the animal in its entirety. This brings us, believe it or not, to the subject of proper operational set-up for acquiring assets of a company overseas—a cross-border carve-out. The analogy in this folktale describes the biggest challenge companies face when executing a cross-border carve-out—the ability to have a holistic, accurate view.
Cross-border carve-outs: A holistic view is an accurate one.
As part of our ChatGPT versus HSP series, today’s expert, Michele Museyri (Director of Private Equity and M&A), walks you through how to develop a holistic view of cross-border carve-outs as well as the three key considerations critical to properly setting up operations for your international carve-out—from beginning (deciding on a legal entity) to end (understanding the role of employees in the success of your acquisition).
To start, here’s the question we asked ChatGPT:
“What entity setup considerations must a buyer take in an international carve-out?”
ChatGPT’s response on entity setup considerations for cross-border carve-outs:
When a buyer is considering an international carve-out, several key entity setup considerations must be addressed. Firstly, the legal and regulatory requirements of the host country must be thoroughly understood and complied with. This includes tax implications, employment laws, and specific industry regulations. Secondly, the buyer must decide on the most suitable entity structure (such as a subsidiary, branch, or joint venture) that aligns with their strategic objectives and operational needs. Additionally, attention should be paid to capitalization requirements, repatriation of profits, and potential double taxation issues. It’s also crucial to evaluate the impact on existing operations, including supply chain and customer relationships. Finally, effective integration strategies should be developed to ensure a smooth transition and business continuity.
HSP’s Michele Museyri responds:
While ChatGPT’s answer is accurate, it’s not strategic enough. It misses both the big picture and specific interdependencies unique to every acquisition. For example, when planning a cross-border carve-out, I typically ask whether there is a TSA. If there is, I’ll want to know how much it will cost, how long it lasts, and what it covers. I’ll also consider the likelihood that the employees (and their works councils or unions) might delay or challenge the offer.
There are typically three key considerations critical to properly setting up operations for your international carve-out:
- evaluating the need for a legal entity
- planning an accurate timeline and events
- and tackling the complexities of acquiring employees.
As important, however, is your ability to fully understand all interdependencies between every process, task, and timeline. Without this holistic view, you’ll wind up with a carve-out strategy based on siloed perspectives. This leaves your acquisition vulnerable to legal, compliance, and financial failures. That’s what today’s blog is all about.
Legal entity’s role in a cross-border cut-out: To be or not to be?
When you embark on an international carve-out, you are essentially inserting your legal structure into the company you’re acquiring. Many people think that to do that, you must form a new legal entity in each location (in this case, jurisdiction). Setting up a legal entity can be time-consuming and requires compliance with recurring requirements (from taxes and accounting to legal filings). I generally counsel clients to take a step back and work with me to assess other options that may be available, including using an employer of record (EoR).
An EoR can be very fast to set up, giving you the flexibility to quickly operationalize in different locations as part of your cross-border carve-out. That said, you should consider the implications on the talent (often a vital part of the valuation) you’ll acquire. From an employee perspective, being “handled” by a third party could result in limited benefit offerings and poor employee experience. And, of course, there’s the legal side of things, which varies by country (for example, some countries don’t even allow an EoR immediately after an acquisition.)
The answer generally depends on your overall goals, the country in which you’ll be operating, legal requirements, and your timeline.
Timing and interdependencies in acquisitions: Location, location, location
One of the biggest challenges I observe with my clients is their struggle to properly grasp the full breadth of events, tasks, and interdependencies in a cross-border carve-out. Because these are nuanced by country, they’re extraordinarily difficult to predict and plan for unless you have in-country expertise.
I’ve managed international carve-outs that took a mere three weeks in the Netherlands and almost nine months in China. Every country has varying requirements for each step in the acquisition process, each with its own timeline. These include everything from setting up a bank account and submitting paperwork to generating the proper employee contracts. The handling requirements are generally the big unknown unless (again) you are familiar with that country and the relevant jurisdiction. For example, some municipalities require a seal, while others require a wet signature and a notary. In contrast, others ask for four copies delivered by a local resident in person—the list is endless.
Employees can determine the fate of your carve-out.
One of the most challenging parts of executing a cross-border carve-out is handling factors beyond your control. In many cases, this is the impact and influence of the employees who are part of the overseas acquisition. How much these employees influence the process is determined largely by country. In many countries, employees have collective bargaining power through a union or similar organization (e.g., Works Council). In those cases, knowing how much power they have is vitally important. The EU is generally recognized to have strong collective bargaining agreements (CBAs), whereas many developing countries do not. Regardless of country, the specifics can nonetheless take time to negotiate.
In a recent acquisition I managed, the client acquired a company that made products and transformed it into a service provider. The problem? The employees who previously received a product discount were legally entitled to comparable financial compensation from the service provider model. As you can imagine, it took quite some time to arrive at the right “math” to achieve what was anything but an apples-to-apples comparison.
That’s why I always recommend that my clients consult an in-country expert. This helps them assess the viability of their acquisition, in part based on the employee considerations. I’ve seen clients almost walk away from a carve-out in Germany because the employee bargaining requirements did not align with the acquisition. Always keep in mind that if you can’t sort out employee contracts, no work gets done!
Overseas carve-outs: Mind the gap with a holistic approach.
While I’ve covered the three big drivers of success in a cross-border carve-out (legal entity, timing, and talent), none will yield success unless the people driving these and other processes work and communicate in concert.
Too often, I get panicked emails from companies who thought they were doing the right thing. The finance person was thinking about accounting and taxes. HR was worrying about employees and benefits, and legal focused on compliance. But, at the end of the day, there was no single person focusing on how all of these things were related—the critical interdependencies that add time, resources, and risk to a cross-border carve-out if not proactively factored into your planning.
When different teams are not working and acting in concert, there are bound to be gaps that leave you vulnerable to failing to execute on a critical task. For example, your lawyers may be focused on corporate matters to incorporate your entity in China. Your HR leaders, however, may not communicate to their colleagues that the employees live across three municipalities in China—which requires the lawyers to register as separate branches in each additional municipality. This will lead to additional payroll registrations that your lawyers may have missed. Your benefits brokers may focus on the supplemental benefits and your payroll provider on the payroll calculations. But perhaps no one has flagged the statutory housing and social insurance fund contributions. And to top it off, if there are no boots on the ground already working to set up a local Chinese bank account, you won’t be able to make the necessary social security remittances and other essential payments.
Consult an expert for best results.
For a cross-border carve-out that doesn’t leave you filling in the gaps and wishing you had known more sooner, consult a global expansion expert who can help you proactively plan a holistic strategy and deliver the in-country expertise that is so critical for a successful execution.
The best way to ensure the success of your overseas acquisition is to hire a global expansion partner who understands—and can execute—across all areas critical to your carve-out—not just a subset.
The HSP high-touch, hands-on approach sets us apart and is a cornerstone of our personalized, bespoke solutions. Contact us today so that we can start delivering your custom solutions.
