There is no single right answer for hiring overseas employees UK SME founders tend to ask about, but the wrong choice can cost you significantly more than the hiring itself. Whether you are eyeing a developer in Portugal, a sales lead in Germany, or a customer success hire in Canada, the route you take matters as much as the person you hire.
Three main options exist: engage the person as an independent contractor, use an Employer of Record service, or open a legal entity in the target country. Each has a legitimate use case. None is universally superior. What varies is your risk tolerance, your timeline, and how permanent you expect the arrangement to be.
The contractor route: fast but fragile
Most SMEs start here, and with good reason. Engaging someone as an independent contractor requires no local entity, no complex payroll, and minimal setup time. You agree on a rate, sign a services agreement, and pay invoices. It feels clean.
The problem is that ‘contractor’ is a legal status, not just a label you assign. Many countries, including Germany, France, Spain, and increasingly the Netherlands, apply a worker misclassification test based on how the relationship actually operates, not what the contract says. If your contractor works fixed hours, uses your equipment, follows your direct instructions, and has no other clients, most jurisdictions will treat that person as an employee regardless of what you have written down.
The penalties for misclassification are not trivial. Back taxes, social contributions, fines, and in some countries personal liability for directors. I have spoken with founders who ran what they considered a perfectly standard freelance arrangement for eighteen months before receiving a compliance letter from a local labour authority. The surprise is always genuine, and always expensive.
Where the contractor model does work well: genuinely project-based engagements, people who operate as established freelancers with multiple clients, and markets where self-employment is legally straightforward and culturally common. The United States, for example, offers considerably more flexibility here than most of Europe.
Employer of Record explained
An Employer of Record, often shortened to EOR, is a third-party company that employs your hire on your behalf in their country of operation. Legally, the EOR is the employer. Practically, your hire works for you. The EOR handles the local employment contract, payroll, taxes, social contributions, and compliance with local labour law. You pay the EOR a monthly fee, typically somewhere between £400 and £900 per employee on top of employment costs, depending on the country and the provider.
This is the option that often makes the most sense for SMEs testing a new market or hiring a small number of people in a country where they have no existing presence. Setup takes days rather than months. You are compliant from day one. And if the hire does not work out, or your plans for that market change, the operational exit is relatively clean.
The downsides are real, though. Cost is the obvious one. Over a two-year period, EOR fees on a single employee in a mid-cost European market can add up to £15,000 or more, on top of salary. There are also limitations around employee benefits, equity arrangements, and the degree to which you can customise contracts. Some EOR providers are excellent and genuinely expert in local nuance; others are essentially resellers of a platform they do not fully understand. Due diligence on the provider matters as much as the decision to use one.
One thing the EOR model does not solve is the question of long-term commitment. If you plan to hire ten or more people in a single country over the next three years, the economics of the EOR route start to deteriorate quickly compared to the alternative.
Opening a foreign entity UK business owners often underestimate
Registering a legal entity in another country, whether a subsidiary, branch, or locally incorporated company, gives you the fullest level of control. You hire directly, manage contracts locally, and build a proper presence in that market. For companies with genuine ambitions in a particular country, it is usually the right long-term structure.
The catch is that it is not quick, and it is not cheap. Incorporation timelines vary from a few weeks in Ireland to several months in some parts of Asia. You will need local legal advice, a registered address, possibly a local director depending on the jurisdiction, and the ongoing cost of local accountancy, audit, and payroll administration. Before you have hired a single person, you may have spent £5,000 to £20,000 just on setup.
There is also the question of corporate tax. Once you have a local entity, you may create a taxable presence not just in that country but potentially in the UK depending on how the entity is managed. Transfer pricing rules, permanent establishment risk, and intercompany agreements all become relevant. None of this is insurmountable, but it does require proper professional support, not a template from a company formation website.
When does it make sense? When you are committing to a market for the long term, hiring at scale, or when the EOR fees have started to outweigh the cost of running your own structure. A rough rule of thumb is that the entity route begins to look financially competitive once you are employing five or more people in the same country for an extended period.
International contractor vs employee vs entity: comparing the three routes directly
Choosing between these three structures is not purely a cost calculation. It depends on four practical questions: How fast do you need to move? How many people are you hiring? How certain are you about the market? And how much compliance risk are you prepared to carry?
| Route | Speed to hire | Upfront cost | Ongoing cost | Best suited for |
|---|---|---|---|---|
| Contractor | Days | Low | Low | Genuine project work, low-risk markets |
| Employer of Record | Days to 1 week | Low to medium | Medium (plus EOR fee) | Testing a market, 1 to 4 hires |
| Local entity | Weeks to months | High | Lower per head at scale | Long-term market commitment, 5+ hires |
The international contractor vs employee distinction is worth being precise about. A contractor relationship built on genuine independence is a different arrangement to employment, and the law in most countries treats it differently. The mistake SMEs make is assuming that if they call someone a contractor, that is what they are. In practice, the relationship has to look like contracting, not just be labelled as it.
A few things that often go unexamined
Termination rules catch a lot of UK founders off guard. In the UK, a short-tenure employee can be let go with relatively limited process. In Germany, France, or Brazil, terminating an employee, even during probation, can involve formal notice periods, severance obligations, and in some cases works council involvement. The cost of ending an employment relationship in certain markets is a real part of the total cost of that hire, and it should factor into your route decision from the start.
Permanent establishment risk is another consideration that tends to get skipped in early conversations. If a person in another country has authority to sign contracts on behalf of your UK company, you may have inadvertently created a taxable presence there. This applies even without a formal entity. It is a specific risk with senior hires or anyone in a sales role with contracting authority.
Currency and exchange rate exposure also affects the total cost picture, particularly for SMEs paying salaries in euros, dollars, or other currencies. The cost of hedging, or the cost of not hedging, is easy to ignore when you are focused on getting the hire done. It becomes harder to ignore once the exchange rate moves five percent against you mid-year.
Frequently asked questions
Can I just pay someone overseas via PayPal or bank transfer and call them a freelancer?
Technically you can make the payment. Whether the relationship qualifies as genuine freelancing depends entirely on the nature of the work and the local legal tests. In many countries, the method of payment is irrelevant to how the relationship is classified. If the substance of the arrangement looks like employment, it will be treated as employment.
How long does it take to set up an Employer of Record arrangement?
Most established EOR providers can onboard a new employee in a straightforward market within three to seven business days. More complex jurisdictions, or markets where the provider has less depth, can take two to four weeks. The speed advantage over entity setup is substantial, which is why the EOR route suits situations where you need someone in place quickly.
Is an Employer of Record the same as a Professional Employer Organisation?
Not quite. A Professional Employer Organisation, or PEO, is typically used in co-employment arrangements within the same country, most commonly in the United States. An EOR is specifically structured for cross-border employment where the provider acts as the legal employer in a foreign jurisdiction. The terms are sometimes used loosely, so it is worth clarifying exactly what structure a provider is offering.
At what point should I switch from an EOR to a local entity?
There is no fixed number, but most businesses find the crossover point sits somewhere between four and eight employees in a single country, depending on the EOR fee and the cost of running the entity. Beyond the pure economics, the decision also hinges on how settled your plans are. If you are still testing whether a market works for you, staying on an EOR longer makes sense even if it costs slightly more per head.
The bottom line
- The contractor route is fast and low-cost but carries real misclassification risk in most regulated markets. Use it only where the relationship genuinely reflects independent work.
- An EOR is the most practical starting point for SMEs making their first international hire. It is compliant from day one, requires no entity, and can be unwound without major structural consequences.
- Opening a local entity is the right long-term structure for sustained, scaled hiring in a single country, but the setup cost, timeline, and ongoing compliance obligations need to be planned for properly.
- Termination costs, permanent establishment risk, and currency exposure are all part of the real cost of hiring overseas, and all three are frequently underestimated at the planning stage.
If you are at the point of making your first overseas hire and still unsure which route fits, the more useful question might not be which option is cheapest today, but which one you can actually unwind if the hire or the market does not work out the way you expect.
