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Three Preliminary Questions to Consider Before Expanding into an Emerging Market

By: Glen H. Waldman

Setting up a new company or expanding into a foreign market can represent a serious challenge for even the most well-funded, well-organized, and creative of businesses. In fact, the process of launching an operation abroad can be so onerous, particularly for enterprises that require special licensing, that some businesses choose to merge their way into foreign markets instead, combining with a local company to gain instant native savvy and cultural credibility, while (hopefully) avoiding some of the legal and regulatory hurdles that might otherwise slow down their entry. But deciding whether to expand by starting your own business abroad or by merging into an existing one requires a careful evaluation not only of the target market, but also of your business. Good advisers, in both the U.S. and the target market, can make sure that you have the information that you need and that you are asking the right questions. Here are three important preliminary ones:

1. What are your time horizons?
The serious business of breaking into emerging markets has one thing in common with the not-so-serious business of comedy: timing is everything. If entering a new international market via merger is an attractive option for many entrepreneurs, it’s because they have more faith in their ability to put together a deal than in the ability of foreign bureaucrats to process paperwork, and also they believe that a merger will help them save valuable time and better position themselves for competition. But the ease of starting a business—i.e., the ease of dealing with bureaucracy—varies widely from country to country. According to the World Bank’s Doing Business Database, starting a business in Sao Paulo—completing such mundane but necessary tasks as registering the entity and obtaining tax identifications and operations permits—requires thirteen different procedures and takes approximately four months. Different business requirements can add more time to the effort: if you need to build a warehouse in Sao Paulo, you may need to wait as much as a year and three months to get the necessary building permits, complete construction, and approvals necessary to put the warehouse to use. Indeed, it can take as much as a month to set up electricity service in Sao Paulo. Moreover, things can take even longer in the Brazilian provinces. Factor in time spent acquiring work visas for employees, buying and registering property, obtaining and negotiating local lines of credit, and the prospect of entering Brazil through an already functioning business in the same market space can look a lot more attractive. Ultimately, however, this option can prove to be similarly time consuming.
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First, in situations where a tender offer for publically traded securities is not possible, and merger with a closely held company is necessary, cultural mores can disrupt or slow negotiations. In cultures where business relationships tend to be based on trust and family names, rather than arm’s-length negotiations, the direct, cut-to-the chase style of some U.S. businesspeople may be counterproductive. In Brazil, business meetings can be highly social affairs, dominated by talk about football and family, so that only long after the ice is broken are terms discussed. As if to make matters more difficult for those of us who like to “tell it like it is,” a Brazilian counterparty may avoid directly saying “no” in favor of making excuses that can string along a negotiating partner who doesn’t know any better.

Valuation and due diligence can also be slowed by cultural differences. Only as recently as 2010 did Brazil’s Generally Accepted Accounting Principles converge with International Financial Reporting Standards, which means that evaluating a potential merger target’s financials may require more than four years to address than negotiations. Ascertaining the target company’s potential liabilities and working out appropriate indemnification provisions may also be complicated, not only by the need to understand the new market’s regulatory framework, but by choice of law provisions in order to make sure that the agreement to indemnify is, in fact, enforceable.

Finally, corporate governance requirements and antitrust restrictions can add considerable time to a transaction. Entrepreneurs should remember that not only do they have to comply, for instance, with the new market’s rules for buying out minority shareholders, but that they require home state’s rules for getting the approval of their own stakeholders for the proposed transaction. In Florida, for instance, a limited liability company whose operating agreement does not supply the provisions under which a merger may take place must produce a “plan of merger,” which must be approved by a majority of the company’s managers who are members. If members disagree about the expansion plan, or are attempting to use their disagreement to the expansion plan as leverage in other matters, a round of negotiations at home will be required, in addition to all of the efforts abroad. At some point, without certain potentially lucrative synergies between your enterprise and the target company, a 120-day period to start a new entity abroad may begin to look quite attractive . . . .

2. Are you prepared to deal with corruption?
In recent years, the U.S. Department of Justice and Securities and Exchange Commission have stepped up their enforcement of the Foreign Corrupt Practices Act (“FCPA”), a federal law that makes it a crime for U.S. persons to bribe foreign officials and requires public companies to maintain certain records and internal controls to ensure that companies avoid “slush funds” or kickbacks to certain foreign government decision-makers. The FCPA permits so-called “grease payments”—i.e., the nominal amounts you may need to pay a bureaucrat “on the side” to process an application, and relaxes its record keeping and internal control requirements for U.S. firms operating abroad whose public company owners hold less than 50% of their voting power. Notwithstanding these and some other concessions that the law makes toward the unfortunate reality that bribery and official corruption may be rampant in some markets, aggressive prosecution tactics have led some corporations operating abroad to institute compliance programs and to “outsource” conduct that might run afoul of the law to local companies in which it holds no interests.

3. Would you be better off entering the market by other means?
Joint ventures, distribution contracts, franchise agreements—there are lots of other ways to access emerging markets, and these can be the building blocks of later expansion. Some countries, such as India, allow foreign companies to operate within their borders by registering a branch office. For some businesses, an intermediate step like this might be the right one. As any comedian will tell you, when it comes to timing, speed alone seldom helps.