FX Risk Advisory: Going Global in 2020: Insights for innovation-sector companies

Key takeaways

• US-based technology and life science companies are going global earlier in their life cycle
• Companies are reducing their use of the UK as a regional hub due to Brexit
• Consider the long-term when making decisions that lock you in and are painful or costly to change later
• Currency risk is a central financial consideration when expanding overseas, often overlooked

Innovation-sector companies are going global earlier and earlier in their life cycle, making global expansion a hot topic. Will Joyce, who oversees foreign exchange (FX) data analytics at SVB, notes that a majority of SVB clients now send their first international wire within three months of opening their first bank account, whereas five years ago most businesses took multiple quarters to reach that step.

Throughout 2019, SVB held a series of events in 8 cities across the country, bringing together innovation-sector companies and business partners to discuss international expansion. Participants shared their experiences operating internationally, including the challenges they faced and their best thinking about how to address them. The panels covered a broad spectrum of financial and operations considerations for international companies at various stages in the corporate life cycle. The roundup below summarizes some of the key insights shared at the events.

Gauging the changing global corporate landscape

 Many participants raised issues related to shifts in the international business climate, particularly in Europe—the leading destination for international capital and expansion among SVB’s client base. The UK and Ireland historically have been the most popular places to establish regional European corporate headquarters: the UK due to its prominence as a global financial center and Ireland for corporate tax advantages. Today innovation-sector companies are rethinking their approaches.

With respect to the UK, event participants indicated that they are increasingly considering establishing operations there only to gain access to the country’s market, not to establish European regional headquarters. While the UK remains an important individual market, especially in light of Brexit-era tax breaks and business-friendly incentives, Brexit presents a range of unknowns that could affect trade, supply chains, work-permitting and immigration with the rest of Europe. Countries such as Spain, Netherlands, and Germany are being considered as regional hub alternatives.

For decades, US companies have based European operations in Ireland to capitalize on the country’s favorable tax status. Companies would optimize tax liabilities through the transfer of intellectual property overseas for purposes of revenue recognition there. The 2017 US tax reform law changed the tax calculus by cutting corporate taxes from 35% to 21%. As a result, many companies are opting to simplify their tax structures and recognize revenues directly under the US parent, to the extent their business practices allow for centralization of billing and collecting schemes. For companies that must incorporate abroad for reasons beyond tax, Ireland remains an important destination among the innovation economy due to its business-friendly landscape, talent availability, and quality of life.

Insights from our clients

One of the key roles we play for clients is to introduce them to the Silicon Valley Bank network: other clients who may have similar challenges and opportunities, as well as trusted partners who can help clients navigate a wide variety of issues including global expansion. A number of SVB clients attended the events and shared their insights on the topic of global expansion. Finance and legal professionals from ContextLogic, Lob, and StitchFix participated in our San Francisco client panel discussion; the treasurer of Guidewire joined our Palo Alto event; and representatives from Tableau and Rover participated in the discussion in Seattle.

A few important takeaways from these discussions:

• Preserving corporate culture is important but increasingly challenging as companies venture abroad. The beginning of a push overseas is a good time to identify the values and other qualities that are central to your culture, and to take steps to emphasize them when making decisions related to hiring, acquisitions or organic growth.
• Build the global subsidiary and banking infrastructure you’re going to need in the future, not just the one you need today. A piecemeal approach to establishing global structures may lead to operational inefficiencies and added cost. Integrate your company’s vision and the global banking needs it will require tomorrow into your planning today.
• No ERP system does everything well. Look for the solution that works best for your firm’s specific situation. Start early, tap your network for help, and don’t fall in love with the first demo you see.

Consider subsidiary structures carefully

Event participants had fruitful discussions around the types of subsidiaries to establish when planning to carry out particular types of international operations.

Employer of record (EOR) and branch office structures can be expeditious, cost-effective options to get up and running when dipping a toe into a new market. Under EOR arrangements, a contracted third party handles all formal employment responsibilities, whereas branch offices effectively operate as foreign outposts of the U.S. parent company.

The relative simplicity of these structures naturally comes with tradeoffs. For example, prospective employees may perceive EOR and branch office arrangements as temporary, potentially making talent recruitment more difficult. Panelists addressing this topic stressed the value of thinking two or three steps ahead when considering which type of subsidiary structure to employ, to implement a structure that will meet tomorrow’s needs as well as today’s.

A business expanding into a country for the sole purpose of setting up an R&D facility, not to earn revenues in that country, might want to establish a cost-plus entity. This option might take a bit of extra work up-front, but it could smooth the process of funding the facility’s operations for years to come.

If you are entering a country to expand your company’s revenue base, the best choice of subsidiary structure will depend on a number of factors. Consumer internet or platform companies that currently collect overseas through payment service providers (PSPs) may have an opportunity to improve efficiency by establishing an in-market subsidiary to receive revenues. Sylvan Martha, Founder of First European Data Rep BV, a firm that advises clients on domiciling in Europe: “Setting up a regional entity as a revenue collecting hub could allow substantial savings,” Martha told event participants,” and could help grow your client conversion because of lower bounce rates.”

That’s just one example; other issues that may influence the choice of structure include transfer of intellectual property (IP), your billing and collection strategy, and the accounting presentation you want to employ. 

How to manage currency risk

The events also addressed the issue of currency risk and how to help manage it.

You have a currency risk problem the moment you have capital, operations or sales overseas. Generally speaking, in any given year you can expect a double-digit move in currencies: The trading range for the euro versus the US dollar has averaged +17% over the past 30 years, and some years have more extreme fluctuations. For example, the relative value of the euro to the US dollar changed by more than 30% in 2008 as a result of the US financial crisis.

Moves like these have important implications for companies. The issue typically shows up first on the cost side. For example, consider a series B company with $10 million of planned overseas expenses over an 18-month period. A 17% appreciation in the euro will cut the company’s runway from 18 months to 16 months—forcing the firm to make an early return to investors for additional funding.

After identifying this risk, the next step is to quantify it. Active management of FX starts the moment you start thinking of overseas revenues, expenses and other transactions in foreign currency terms. At this stage you can determine your company’s FX budget rates and embed them into the forecasting, planning, and analysis process. This exercise requires buy-in from stakeholders across the organization, but it’s essential to put your FX risk in necessary context.

Certain guidelines can help you determine if your FX risk is material enough to warrant mitigating it. Generally speaking, the size threshold calls for hedging FX risks if at least 20% of top-line revenues, operating expenses or earnings are projected to be realized in foreign currencies. You may find that FX risk currently is immaterial or unimportant. Even in that case, it can be valuable to have worked through the process of quantifying the risk, because the exercise establishes a framework you can use to identify and measure risk as your company scales. In fact, we find risk discovery is an important part of IPO readiness.

You have a number of options if you find that your FX risk needs mitigating, including several that don’t involve derivatives. For example, you may be able to hedge your currency risks using strategies built solely on business operations decisions, such as:

• Buying and holding foreign currency before it’s needed
• Incorporating FX risk-sharing agreements or legal language into long-dated overseas contracts
• Establishing cost streams, such as procurement or letters of credit, in countries where revenue is earned

It is generally recommended that you exhaust all such natural remedies before implementing a derivatives-based program. The objective of such a program should be well-defined, placed in the context of business objectives, and documented in a policy. For instance, hedging future overseas cash flows with forward contracts* for purposes of insulating gross-margin ties the strategy with shareholder value. Gains or losses on the hedges themselves should never be a focus, instead focus should be placed on business results and management KPI’s. Education across the organization is necessary to establish and run a hedging program, and an internal champion is required for its ongoing success.

The dollar forecast

Silicon Valley Bank’s Currency Strategy team expects businesses to contend with a softening dollar over the coming year.

“We are at an inflection point in the direction of the US dollar,” says Scott Petruska, SVB’s Chief Currency Strategist. He sees the US dollar weakening into 2020, reversing years of strength, as lower interest rates push down the value of the greenback relative to other currencies. Petruska expects this change to drive greater volatility as well. He recommends prioritizing FX in your business planning and developing a framework for identifying, quantifying and managing currency uncertainty.

Talk to us

With an increasing number of US-based technology and life science companies going global earlier in their life cycle, it is critical to make good, long-term planning decisions.  Issues such as global subsidiary location and structure, tax planning, and ERP systems are a few examples as well as currency risk considerations.

If you’d like to discuss your specific situation or explore the merits of active FX management, contact your SVB FX Advisor directly, or reach out to me, Ivan Oscar Asensio, Head of SVB FX Risk Advisory at iasensio@svb.com.

Learn more

Read SVB’s related guidance on FX management:

• FX Risk Advisory: Why passive FX management falls short
• FX Risk Advisory: How currency movements can affect your global business

See an overview of our full FX services at www.svb.com