Managing Your International Empire:Using An International Network Of Accountants To Control "Uncontrollable" Risks

Monday, September 1, 2008 - 01:00

Nothing keeps in-house counsel up at night like uncontrollable risk. Nothing keeps a CEO up at night more than a significant investment sold to the board based on carefully considered risks and returns over which he or she has little control. International trade is a reality. Companies that are not in this game will eventually fall by the wayside. The seemingly uncontrollable risks of this often expensive venture are of the sort nightmares for executives are made.

Competition today dictates:

• buying from the suppliers that provide the best value,

• selling into economically optimal markets, and

• doing it from the best possible locations.

Cross-border supply chain management, product and service quality issues, intellectual property protection, corruption and ethics risks, and the ultimate integration of the many players in a process can be daunting for a middle market company. The variables often cause a company to shy away from maximizing its potential. How can it possibly oversee such a sprawling empire?

International business, done properly, expands revenues, reduces costs and improves profitability. International business done poorly can add undue risks, increase costs and kill a company. Failing to do business internationally, however, will eventually cost a company even more, perhaps everything.

The world is shrinking. Similar-sized businesses in other countries are already international. Uniform international rules are growing stronger and communication systems make world trade more efficient. Time zones allow for 24-hour production and the quicker turn-around demanded by clients. International trade is no longer on its way. It is here.

U.S. companies should secure services such as the following from providers that maximize profitability regardless of where they are located in the world.

• Engineering, design and professional services

• Parts

• Transportation and logistics

• Final assembly and finish

• Product distribution

• Sales and marketing

For U.S. middle market companies the risks are difficult to adequately quantify. The least costly way of getting into international markets is to operate through independent local agents, representatives or licensees. Operations generally begin small and do not justify a heavy up-front investment in property or people. These local players also understand the markets, the language, the customers, the employees, the customs, laws and business practices of both that country and surrounding markets in a way the U.S. middle market company does not.

What dynamic middle market companies need are trusted local professionals to periodically review the operations of the company's agents, representatives and partners. Ideally these trusted professionals should be connected to others in the various countries in which one does business and to a U.S. firm who can report to the company management. The company then has a network of variable cost in-country support to help reduce its international risks and most important, increase its international competitiveness and profitability.

There are many basic steps in getting started. At a minimum, the U.S. company should:

• Hire experts to do significant legal and reputational due diligence on all foreign partners and their officers.

• Secure references and speak to those references to get a feel for the trustworthiness of the entity and its officers.

• Consider contacting local government officials, the U.S. embassy, the World Trade Organization, U.S. or international trade organizations, and anyone else one can find who might shed some light on the company it is evaluating.

The parties may have even been working together in what seems like a positive manner for some time. In the end, however, the U.S. company has entered into a contract with an entity it barely knows, often in a country with emerging rules of law at best, and must rely on that foreign entity to honor a contract of dubious enforceability.

The court systems can be extremely unreliable and expensive. The laws are likely to be complex and enforced sporadically. Common business practices vary. The culture is different. Even though both parties seem to be speaking English, it is not clear the parties are really communicating in the same language. Once hands are shaken and the parties part ways, how does a company know that what has been agreed upon will actually be respected?

Unlike their giant counterparts, U.S. middle market companies may not be able to afford to have employees on the ground in all of the countries in which they do business to verify that in fact they are getting what they bargained for. Many middle market companies have only a few foreign offices. They are frequently quite distant from one another to cover specific foreign markets effectively. These independent entities are usually responsible for different parts of the production to sales processes. As companies become more sophisticated, partners, agents and affiliates are often located in widely different parts of the world and are frequently redundant to one another to hedge against inherent international risks.

Even in the U.S., partners breach contracts. The general counsel and CEO know full well that it is inevitable that many foreign partners will violate contracts to at least the same degree. Incentives to cut corners and to drive profits are strong and in many emerging markets there are few restrictions on behaviors we consider unethical or inappropriate. The problem is the breach could have much greater down-sides. Without some form of periodic oversight, the company cannot know whether the partner will:

• Pay bribes to secure business in violation of the contract and international law?

• Implicate the U.S. company in its wrong-doing?

• Pay all royalties, license fees or other amounts due the U.S. company in accordance with the arrangement?

• Accurately report sales, material costs or other critical financial numbers that measure success?

• Ship on time, bill properly, maintain quality and communicate efficiently?

• Account and report financials properly?

• Sell product under the table, steal clients, or pirate intellectual property?

• Act ethically, pay appropriate wages, hire children, pollute the environment or do whatever was mutually agreed upon and important to the company?

• Report factors that could suddenly impact the agreement like changes in company control, financial instability, changes in the country's government, loss of key personnel, etc.?

For the medium to small U.S. company, playing the global trade game with the big boys is risky but both an inevitable and necessary part of business. These are all questions middle market and even small U.S. companies regularly ask and do not know how to answer.

Middle market companies with foreign operations are increasingly employing in-country accountants affiliated with U.S. firms to periodically check in on the local partner. Many U.S. accounting firms, like UHY Advisors, are part of international networks of related and vetted firms. It is often much more cost-effective to utilize the services of a local accountant who understands the local culture, language and financial reporting processes than to employ someone to cover operations in multiple countries in which he or she has indirect experience.

This system allows the company to develop an even broader and more diverse international network with greater certainty that contractual terms that underpin the investment will be respected. In fact, the accounting firm can often prove very helpful in identifying tax and other benefits to locating an operation in one country or part of a country versus other options.

A partner in the U.S. firm ordinarily oversees the arrangement. He or she will work with the general counsel and CFO to establish the parameters of these inspections. What should be reviewed, how often and what should the reports include? The in-country professionals are then trained on when to periodically visit the partner and what review procedures should be used to check on accounting, money-flow, internal controls, payments to government officials, operations, and other activities important to the U.S. client.

Reports are delivered to the partner in the U.S. firm where they are reviewed carefully, cleaned up, organized, summarized and delivered to the general counsel. If there are questions, the U.S. partner will clear them with the affiliates before the reports are delivered. Sometimes a closer inspection of the foreign partner will be warranted. Issues presented in the report can be caught and addressed early, before they become serious and costly problems.

Contracts should permit these audits. They should be unannounced, unpredictable and sporadic. These audits should also be as unobtrusive as reasonably possible. Use of local professionals will make sure that local customs and attitudes are respected. That the firm is associated with a significant U.S. entity will insure that integrity and quality will be maintained.

It is tough enough to do business in the United States or even in nearby Canada or Mexico. As markets range in Asia, Eastern Europe, India and the Middle East, it is becoming increasingly important to participate. Different countries provide companies with various unique advantages. Identifying these, taking advantage of them by finding talented and trustworthy local partners, orchestrating the activities of the players and using an international accounting firm to help create an infrastructure to oversee the process allows a medium to small entity to effectively take advantage of the benefits of international trade and compete like the big guys and like their comparably-sized foreign competitors.

International trade is inevitable. Using an international network of accounting professionals can help you expand your empire while controlling the risks and maximizing your profits.

Jeffrey Harfenist is a Managing Director of UHY Advisors FLVS, Inc.; the Houston Practice Leader for the Forensic, Litigation and Valuation Services Group; and the National Fraud and Forensic Service Line Leader. He is also a Certified Public Accountant (CPA) in the State of Texas.

Please email the author at jharfenist@uhy-usa.com with questions about this article.