Reflections on setting up a consulting agency with founders in New Jersey and Amsterdam.
Creating up a startup with bases in two countries is complicated. Don’t underestimate the logistical challenges (in additional to cultural); and expect to pay more than you want in legal and accounting fees.
In our case, with the US and the Netherlands as our bases, it’s probably not advisable to setup a subsidiary in the beginning. Better to spend time building your actual business than iterating on legal and accounting formulations. This also reduces the amount of uncertainty when consulting with local agents who probably have never dealt with international constructions before. You’re not Apple or Google yet.
Here's how we originally set things up: => 10,947 easy steps to setting up a company
See below for a somewhat detailed breakdown of the evolution of Proto’s legal entities, and why these changes have come about.
Sean and I started our consulting firm Proto in September of 2013. You can read about how we set things up and what our costs for the first year looked like [here]. We've built ecommerce sites such as Pictli.com link
2.5 years after the founding, it seemed like a good time to reflect on the structure we setup and what changes we've made and why. A quick recap:
Sean lives in New Jersey, I live in Amsterdam. We are the co-founders.
The original contributing team of Niels, Kim and Auke all live in Amsterdam.
We wanted to setup a simple US entity (i.e. an LLC) however I also needed a BV (Inc equivalent in the Netherlands) so that I could a) house my 30% ruling [link] to the BV, and b) sign contracts and manage payroll on the NL side.
Our plan was always to pay out all revenues to ourselves and our partners; we did not intend to turn a profit.
We did not have a clear picture of how tax liability would level out between the entities, but we assumed that if the US entity was a parent to the Dutch one, then any gains on side would be canceled out by losses on the other side, or vice versa.
We also did not know how the transfers between entities were supposed to work -- shouldn't we just book an inter-company transfer in our US and NL ledgers? Turns out the BV needed to invoice the Inc for expenses (my payroll as well as that of my Dutch colleagues) in spite of the fact that the BV was a subsidiary.
The legal and financial advisors we spoke with were unclear as to whether we could preserve the tax benefits of the NL<=> US tax treaty if we setup an LLC as a parent to a BV. This was an uncommon setup.
So, because the path was already trodden, we setup a Delaware C-Corporation and a subsidiary Dutch BV. C-Corporations are subject to double taxation [link] but we felt we had no choice.
A side effect of this setup is that your US corporate tax return is fucking complicated and expensive to have done (nearly $5k!! for our first year).
Aside on partner equity
Separately, we went through various machinations trying to determine the best equity incentive plan for ourselves and our contributing partners. Initially we were going to do a profit share arrangement -- if the company did well, then the partners who were significant contributors would benefit from that success. But what legal form would that plan take? would there be any vesting? would it be tied to the BV or to the Inc?
In the end, we granted options (NSOs) in the Inc to the Partners. Again, this was a well trodden path, and trying to do something non-standard just lead to FUD (and what felt like excessive legal fees). After all, we're just a startup consulting firm, not a Fortune 500 company (yet!). The decision to grant NSOs comes back into play below.
During the intervening years, things have played out as follows:
Almost all of our business has come from the US, in spite of a concerted effort to prioritize growing the business on the European side, specifically in Q1 2014 to Q3 2015.
- I can't explain exactly why this has been the case, but my sense is that our flat hourly rate -- a low to moderate rate by US standards -- is viewed as too expensive by Dutch businesses, especially Dutch startups who seem to have less capital at their disposal than their US equivalents.
As a result, all of our revenue came from the US Inc, and the vast majority of our costs were incurred by the BV (in the form of labor; only Sean's salary came out of the Inc).
What we learned is that if the BV is just a cost center, then there's no benefit to it being a subsidiary to the Inc. With no profits on the BV side, there's no need to cancel anything out on the Inc side.
Thus, we made the decision to
spin outProto BV, i.e. de-parent it. I still needed Proto BV to house my 30% ruling (and thus to run my payroll), but that's effectively the only reason to keep it around. By de-coupling Proto BV from Proto Inc, our Proto Inc tax return gets a lot simpler.
- One side effect is that any business we do in the NL companies will now be directly with Proto Inc, so we ensure that our IP and contractual obligations remain housed in the proper entity. So that means marshalling between euros and dollars, though with few/no Dutch clients, that doesn't matter!
What's more, now that Proto Inc is
unencumberedby an international subsidiary, we can convert Proto Inc into an S-Corporation, which does not result in double taxation -- instead it provides
passthroughtax benefits for the owners.
- HOWEVER, the one gotcha to this conversion is that an S-Corporation can NOT have foreign shareholders. I told you we'd get back to those NSOs. If any of the Dutch partners choose to exercise their options, then that will trigger a conversion BACK to a C-Corporation. All parties have been made aware of this consideration, and since we're principally doing client work, those options are not valuable. If we build an app that blows up, then there will be value in those options and it will make sense to devote financial resources to converting back to the C-Corp.
What would we do differently?
Looking back, I want to say that there's a lot we should have done differently. We could have saved time and money by starting with the structure that we have now put into place. Though, that's a 20/20 hindsight situation, since we couldn't have known that business would be so hard to come on the NL side.
Amsterdam wants to be the Silicon Valley of Europe etc, etc.
Nevertheless, it's clear we took an optimistic view on our prospects (
we will get business everywhere!) instead of a more measured approach
let's find a way to start simple, and expand/evolve from there. When entering the realm of international business, it is extremely difficult to get clear answers to tax and legal questions. People can tell you about the NL implications, or the US implications, but not how those two play together. We consulted a LOT of advisors and nobody really had specific experience that was instructive for us.
Still, we could have started with an LLC on the US side and a BV on the NL side, and run all contracts through the LLC. The BV would serve only as an adminstrative entity on the NL side, and it invoices the LLC for expenses (as a customer of the LLC). A drawback to that is that NL clients have not always been excited about their contracts being governed by Delaware Law, nor paying in dollars. I don't believe that's an insurmountable challenge though, but when you're
trying to get to YES it would be nice not to have annoying impediments like that.