Five Surprises for Startups Expanding to Europe

Robert P. Mollen, Counsel at Fried, Frank, Harris, Shriver & Jacobson (London) LLP.

I’ve written a number of blogs to help European emerging companies set up in the US. Increasingly, though, I’m finding that these blogs are also being read by US and other non-European startups.

While there are common issues in all international expansions http://bit.ly/CrossBorderExpansion, and there are things that you can do to try to manage the associated risks http://bit.ly/IntlExpansion, there are some special surprises for US and other non-European companies when they expand to Europe.

A few of these points may also surprise UK and Irish companies expanding to continental Europe.

So here are my top 5 surprises:

Employment is not “at-will”

In the US, most employees don’t have employment contracts, and employment is theoretically “at will”. While as a practical matter US employers who are managing employees out do make a voluntary exit payment, and receive a release from liability in exchange (in addition to paying unpaid salary, of course), exit payments generally are not required by either statute or contract.

Europe (including the UK and Ireland) is very different in this respect. All employees have employment contracts, which will include notice periods or other rights to contractual payments on termination. These employment contracts are subject to statutory requirements, which may include a requirement that the contract be in the local language.

Permanent employees will have statutory rights to “redundancy” payments on termination, depending on their length of service, and the liabilities associated with these rights can be very substantial (depending on length of service, sometimes measured in years rather than months).

Additionally, you are likely to have an obligation to consult with employees before terminating them.

Furthermore, employees will have access to employment tribunals in the event of claims of wrongful termination, with the potential for substantial awards. In some countries, such as France, you may find that an employment tribunal’s view as to whether you had a reasonable basis to terminate an employee will be very different from yours!

By the way, particularly in continental Europe, your employees may also be entitled to form “works councils” that represent employees, even if you only have a small number of employees (especially in Germany, where in theory even five employees can form a works council). These works councils have a number of rights that go beyond the scope of this blog, but these can include broad consultation rights or even co-determination rights. Members of the works council may benefit from special protections against termination. While I suspect that works councils are not common startups, you may find that they become an issue in certain circumstances – for example, if the company experiences problems and needs to reduce employee numbers.

Consequently, it is critical that you obtain legal advice before taking on employees, and even more critical that you secure legal advice before terminating employees, at least until you have a better understanding as to how the system works.

Employee-related social charges can be very high

In the US, employer payroll taxes and charges are relatively low. These include social security and Medicare, federal unemployment tax (FUTA), and state unemployment insurance and disability/workers compensation insurance rates (which vary based on state and experience). While employers with 50 or more full-time-equivalent employees have to provide health insurance under the Affordable Care Act (aka Obamacare), most startups don’t hit this size limit until they have secured significant funding (although they may have to offer health insurance to be competitive).

In contrast, employer-paid social charges in Europe can be very high. In France, for example, employer-paid social charges amount to something like 40 – 46% of gross salary. While the French rates are higher than many other European countries, many European countries have rates that are very high by US standards.

Data protection rules are significantly stricter than in the US

European data protection rules are already significantly stricter than those generally applicable in the United States, and they soon will be stricter still.

Privacy rights are a major concern in the European Union, particularly in countries like Germany that historically have had experience of abuses in this area. Obtaining specific customer/user/employee consent to secure, retain and process personal information is critical, and the definition of personal information is wide.

While all emerging companies coming to Europe need to be sensitive to these issues, they are likely to be especially important for companies relying on “big data” or other data analytics.

Even more restrictive data protection rules will become effective in May 2018 under the EU General Data Protection Regulation (GDPR). The GDPR imposes a series of new or expanded obligations, including obligations to (i) obtain explicit and “freely-given” consent from individuals whose data is processed, (ii) obtain parental consent for data from children, (iii) notify individuals of the right to withdraw consent, (iv) provide data portability, (v) in certain circumstances, provide a right to be forgotten, (vi) protect data, including by anonymizing it, and (vii) report data breaches promptly.

The GDPR applies directly to non-EU based data processors that process data from EU individuals, such as EU customers and users. Consequently, it will be directly relevant to all US startups that collect data from European individuals, whether or not you establish EU operations.

Finally, the GDPR provides substantial fines for breach.

Given the difficulties associated in securing appropriate informed consent to process European source information outside of the EU, you may well determine to process European-source data within the EU. Indeed, this already makes sense under existing laws and regulations. Consequently, you will need to ask your cloud service providers to use European servers.

The GDPR is a complex set of requirements, this is not an area in which I specialize, and this summary is by no means complete. Get legal advice.

Your contract terms may be overridden by mandatory provisions

While the UK and Ireland, like the US, are common law jurisdictions and broadly respect freedom of contract, contracts in continental European jurisdictions are governed by detailed statutory provisions under the country’s civil code. On the one hand, civil code provisions may permit shorter contracts because many terms are addressed under the code. On the other hand, the code may override contractual provisions in ways that you do not expect. Consequently, you should get local advice on your terms and conditions, on your relationships with contractors, distributors and agents, and on other key contractual relationships.

One key area where civil code jurisdictions may differ from common law jurisdictions is by requiring parties to negotiate pre-contractually in good faith, and by providing remedies for a failure to do so. This may impose obligations based on a letter of intent or memorandum of understanding even where the document expressly states that it is non-binding. Additionally, there may be an obligation of parties to inform, e.g., to “lay their cards on the table.” While the laws of certain US states, such as New York, also impose good faith obligations in certain contexts, such as where there is an “agreement to agree” in respect of certain terms of a transaction, the potential scope of pre-contractual good faith is substantially wider in continental Europe.

Value added tax (VAT) is likely to apply to whatever you are selling

European value added tax (VAT) is very different from US sales tax. In contrast to sales tax, VAT applies to most services (other than, e.g., certain financial services) as well as products. You will pay VAT on the goods and services that you buy, will charge VAT on the goods and services that you sell, and will probably be able to obtain a reimbursement of the VAT that you pay once you are registered for VAT, on the basis that you are an intermediate supplier (not the final customer).

The VAT system is very complex. Specialized VAT advice will comprise a key part of the tax advice that you will need in setting up in Europe, since it will apply even before you have any profit to report.

Conclusion

Expanding to any new international jurisdiction requires that you come to grips with stuff that you don’t expect, as well as the stuff that you do. This list is by no means comprehensive, but it hopefully will alert you to areas where you will need help from appropriate advisors.

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This discussion is not intended to provide legal advice, and no legal or business decision should be based on its contents. If you have any questions or comments, feel free to contact [email protected].

You will find a listing of Bob’s weekly startup blogs on US and international expansion and early stage financing here: http://bit.ly/StartupGuidesIndex