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When to Shift from PEO to Legal Entity

Alex Margolin August 12, 2019

In the past a company looking to hire workers abroad only had one real option – to open a legal entity in each country where it wished to operate. It needed the legal status in order to run a proper payroll in compliance with all tax laws and labor regulations.

The process took time, effort, and money. In most countries, collecting and filing all of the necessary paperwork and receiving approval from the government took several months, at the least. It cost a fee to file for the entity, and the process was complicated enough to require the services of qualified accountants and lawyers. Then there were extra costs in finding the workers, locating an office, and finding out the standard salary, benefits, and perks workers expected in each country.

It was also a significant risk. Beyond the money spent setting up the entity, there was also a chance the new venture would fail. The entity would need to be shut, which was another undertaking that required more time, effort, and money.

Today, businesses have options for hiring workers abroad without having to open an entity from day one. They can take advantage of the growing number of contractor and hire them as independents. Contract workers are self-employed and companies hiring them are not required to withhold taxes from their paychecks.

They can also work with a Global Professional Employment Organization (PEO) to hire in another country. With a Global PEO, a local vendor becomes the employer of record and the Global PEO assumes all of the worker management responsibilities including payroll. However, the hiring company directs the worker in all work tasks. In a PEO, the company is essentially gaining an employee and making payments in full compliance of all local laws without opening an entity of its own.

A Global PEO is ideal for small or medium size companies looking to hire a small number of workers, often in the range of 1-5, in a foreign country for a short or open-ended period.

Advantages of Using a Global PEO to Hire Abroad

A Global PEO allows companies without local entities to function like multi-national corporations, but without giving up any of the agility that goes with their relatively small size.

When to go with a Global PEO?

Scale into a new market quickly

A company can enter a new market with a Global PEO in far less time than it takes to open an entity – a period of weeks, if not days in some cases – so it’s ideal for companies that need to hire a worker immediately or that want to on-board workers while an entity is being setup. The quick turnaround time allows companies to compete quickly anywhere in the world. That could be a decisive edge over top competitors.

Short-term projects or engagements

When a company knows the worker(s) will only be in place for a limited time, ranging from a few months to a few years, a Global PEO makes more sense than setting up an entity. Just as a Global PEO makes it easy to enter a market, so too it makes it simple to exit the market, or to change status at any time. If it looks like the project is going to be worth the cost and effort to open an entity, it’s easy to move from one to the other.

Testing a new market

One of the great advantages of the modern era of the global workforce is the ability to test the market before diving in all the way. Companies can see if their product is viable in the new market, or evaluate the local talent pool abroad. A Global PEO is a quick, simple, and low-risk way to test-drive the market before committing long term.

Mitigate risk and liability associated with employment

With a Global PEO, companies are essentially outsourcing their liability to a third party. The legal risk remains on the employer of record, so the hiring company is not liable if a worker is injured on the job or any other unforeseen problem occurs.

A Global PEO is an excellent option for companies at different stages of growth and commitment. But as a company’s global workforce grows or gains a foothold in a foreign market, it’s important to recognize the signs that it’s time to consider opening a legal entity.

Signals For Changing To Payroll

While a Global PEO offers the quickest entry into a foreign market, the employees are still under the official employ of the PEO or a local employer of record. Ultimately, that limits the options employers have when it comes to contracts. Working through a PEO signals to potential partners that the company may not be as stable in its local presence as it would be with a legal entity and all of the obligations that go with it.

Employment expert Nirvano Brans, VP Sales at Papaya Global, lists three factors that could indicate the time has come to move from Global PEO to legal entity:

A long-term strategy for overseas expansion 

Having maximum agility makes sense for a company in the early stages of an overseas operation when it is unsure how large a workforce it will need. But once a strategic decision has been made to build a permanent presence, it becomes cost-effective to open a legal entity.

Having a legal entity allows a company to engage in better tax planning and apply for grants, subsidies, and incentives in a particular country.

It also allows businesses to build their company culture in the new market. When employees feel connected to the long-term goals of their company and feel part of its mission, they are more engaged as workers and more likely to remain with the company, reducing the need to hire and train their replacements, saving costs in the long term.

A substantial number of employees

A Global PEO makes it easy to hire and pay workers, especially when the number is lower than the costs of opening an entity. At a certain point, however, it becomes more cost effective to open an entity to pay workers. It allows the company to eliminate the fees it pays to the PEO, which are typically based on the number of workers, and it lets the company take advantage of better tax rates in some countries.

“At some point, it simply makes more sense to employ rather that outsource employment,” Mr Brans said. “This threshold depends on many circumstances but I typically see the tipping point around 15-20 workers in one country. That’s typically the point where companies realize they’ll stay in the country for longer period or permanently and that’s where having an entity with payroll becomes more cost effective.

“It also depends whether they have 15 people on day one or if it takes them five years to get to 15. In the former case they may decide sooner that it’s worth establishing permanently.”

Plans to engage in full commerce and contracts

A Global PEO provides speed, agility, and risk mitigation. That’s ideal for the early stages of a business in a new market. As a business matures and its presence is more established, speed and agility become less important than presence and stability.

A full legal entity could also open up business opportunities that were unavailable, such as engaging in supplier/client contracts through local billing and invoicing.

“Clients may be hesitant to do business with a company that’s not actually registered in that country,” Mr. Brans said.

Papaya Provides Global PEO Services and Helps Establish Legal Entities

Papaya can help your company navigate the challenges of global expansion our global PEO works has local vendors in more than 100 countries to serve as employers of record. We also provide guidance and support for companies seeking to move from Global PEO to full local entities to ensure each company maximizes its potential at every stage of growth.