Startups: Can Offshore Be An Opportunity?

A few years ago, out of a Stanford online class, I kicked off a project with two Russians friends on offshore business setup. The company, llcbox.com, aims to innovate a really niche market and include company formation, accounting and in general, finance services. Sometimes, we are asked: does it make sense to incorporate your startup offshore?

In this article, I’ll try to outline some hints in order to guide you to the right direction or, at least, to make you think about this opportunity. That said, always remember, that this is a very crucial decision and, unless you master local laws and accounting principles, you should always consult with serious professionals before making a choice.

What Does “Offshore” Really Mean?

First of all, it’s very important to define what “offshore” means and refers to. Since 1980, the term “offshore” describes a legislation providing corporate or commercial services to non-resident companies. Those legislations, or countries, are generally small but with very strong financial centers. Examples:

• Luxembourg, Cyprus, The Netherlands
• British Virgin Island, Hong Kong, Bermuda, Panama
• Jersey, Isle Of Man, Delaware

Why Are They So Attractive? Well, there are many reasons behind this:

Tax Benefits

Profits and withholding taxation are normally ridiculously low and not comparable to local on-shore taxation (especially with regards to EU countries).

Asset Protection

Not everybody lives in liberal countries. You build your fortune and you don’t want to risk to lose everything because of a government’s law changes. Most of the “offshore” legislation offer a very advanced and stable law system where you can stock your assets without much fear for the future. Also, as explained above, their banking systems are very stable and it’s a great thing if your local banks are not solid.

Holding Management

Complex company structures and multinational companies are generally managed by a leading company which must be placed in a country respected and accepted by different stakeholders. Having it placed in a stable and fair legislation is common sense.

As you can see, I didn’t mention any “low living costs”, “reduced manufacturing costs” and the like. Why? It’s simple: those reasons don’t apply to the “offshoring” even if, this misconception is broadly accepted.

Typical Startup Needs

Should a startup chase the advantages explained above? Generally, it’s a big NO. The main reasons:

Best Practises

Backed by best practices, entrepreneurs should focus on testing local markets, pivoting ideas and refining their business models. None of those needs really stick with spending resources and times on building complex company structures. Also, a startup is normally an entity generating more losses than profits, so it doesn’t really make sense to incorporate in a place you don’t know and that is likely to cost you some good money without the benefits of less taxes, for instance.

Credibility

A common problem experienced by startups is credibility: to convince a customer you must spend your company’s identity and values. Can an exotic located startup really put out a premium? Definitely not.

Funding

Looking for funding? There might be additional issues: VCs (as I was told by K. Korver, from ULU Ventures, during one of his NOVOED courses) will normally require to incorporate either where your market is or in a legislation they know (in the US, this is normally Delaware). Few of them will take additional risks in case your company is located in the Seychelles, Panama or the likes. Why? They simply need to protect their investments and also knowledge of the local law is a primary aspect.

Limitation

Eventually, also keep in mind that the general trend is to limit the so called “offshorization”, which means that countries are putting in places legislations to limit the offshore benefits especially with regards to tax optimization. This is very visible in EU and Russia.

When It Makes Sense

So the question is: when should you consider this option? Well, there are some exceptions to the points made above and they normally apply to some specific market fields or situations. Below you’ll find some examples that could represent a driver for your choice:

You Hold A Patent

Some of the “offshore” countries are very active in promoting laws to further attract investors and entrepreneurs. Cyprus, one of the most known and respected locations, is famous for the advantages you can get from IP rights exploitation (for further info you can check out my article on this matter here).

Online Betting Industry

If you check carefully, most of online bookies are located in Malta or Gibraltar. Why? Because their legislation is very favourable to this sector and this is quite a standard in the industry. So, it happens that also VC or angels investing in the fields are there or know them very well.

International Team

Let’s suppose you gather a dispersed team and decide to create a company to run your startup: where will you form it? Unless specific reasons, you should pick a neutral country where all the shareholders feel protected. An “offshore” location could really be the right option.

Privacy

Investing in countries like China, Russia or the likes is still a risk. Not because you can go bankrupt (this happens everywhere) but because you are never ensured 100% of laws applying to businesses and business owners. So, what is the general way? You set up your leading company in an offshore country and your operating company will be owned 100% by the holding. For your information, British Virgin Island is the second investor in China, after the Chinese government (you can find an interesting article here).

Conclusion

From the points made above, it’s quite clear that going offshore is not a primary goal for entrepreneurs moving their startup forward. That said, in a highly competitive environment, a small edge can play a difference and knowing benefits of abroad incorporation can be relevant.

By the way: as I noted in the intro, this is a very complex topic and you should always discuss it with experts; legislations keep changing and you must always be up-to-date unless you want to put your assets at risk.

 

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