Explainer: Limited Liability Companies and Offshore

How do SRL's work? and are offshore companies good or bad?

Welcome back to “Explainers” at Moldova Matters! This Explainer is Part 2 of 2 in a series exploring how business organization affects the economy. In Part 1 we looked at the Moldova Stock Exchange and Joint Stock Companies. In Part 2 we will discuss Limited LIability Companies (SRLs) and how they spurr offshoring in Moldova. 

In Part 1 of this series we looked at the structural issues that prevented the Moldovan Stock Exchange from growing into a dynamic (or even viable) financial mechanism in the country. Because of this we found the idea of “Joint Stock Companies” (SA’s), or public companies of any kind, are endangered species in Moldova and somewhat relics of a different time. In Part 2, we will dig into Moldova’s Limited Liability Companies or SRL’s from their Romanian acronym. 

If you’re interested in more about the various legal forms companies can take in Moldova take a look at the Moldova Small Business Handbook which I co-authored for the Moldova Small Enterprise Alliance (AIM). There is a section in Book 1 Chapter 2.1 which covers picking the right structure for your new business. 

As we discussed in Part 1, SRL’s are the primary form of Small, Medium and Large companies in Moldova. But as we will see there is another important structure we need to understand - “offshore companies” with business in Moldova. 

What is “Offshore?”

Offshore is a shorthand term for any business entity that is doing business or owning assets somewhere other than where it is originally registered. For example, a UK company that invests in a furniture manufacturing SRL in Moldova would become an offshore owner or investor in that company. Similarly, a Russian oligarch buying an apartment in New York that he registers in the name of his company in an offshore haven like Nevis is an example of offshoring. 

If you want to get a real sense of how this alternate world of money flows work, check out the movie “The Laundromat” for an informative and hilarious explanation of the Panama Papers Scandal. 

Now there is nothing inherently bad about using offshore structures to do business. In Moldova, there are LOTS of very legitimate reasons for it as we’ll discuss below. Most of the really shady or outright criminal behavior revolves around another word we need to define - “Beneficial Owner.” In offshore speak, the beneficial owner of a company is the individual who actually owns it after you wipe away the layers and layers of paperwork that might obscure their identity. In many countries, the beneficial ownership structure is mandated to be public. In some, such as offshore havens like Nevis, the Isle of Man, and the United States, this information is private or totally unknown. 

So this is offshoring, let’s talk about how it interacts in Moldova. 

Offshore in Moldova

Offshore companies that have business interests in Moldova get a lot of attention for their underhanded or illegal actions. Primarily, disguising their beneficial ownership. In the ongoing case of Ilan Shor for example, RISE Moldova’s investigative team linked various offshore holdings of the defendant (Shor) to the Judge in his case. It appears, but remains unproven, that hiding money flows overseas has allowed Shor to use laundered money to bribe justice officials. In another case, the Moldovan Lottery concession, whereby a private company was hired by the government to run the lottery, has seen huge shifts in beneficial ownership over time. Initially the company was transferred to a Bulgarian organized crime leader and then he sold it on to an unknown Arab Banker. Now it remains rather unknown who actually owns the “national lottery.” In another case, Andrei Spinu, a member of President Sandu’s PAS Party and former chief of staff for the President was reported to have multiple offshore holdings from the US to Hong Kong.  Spinu was a successful businessman and justified himself by noting how Moldovan companies are extremely limited in their functions and many things must be done abroad. 

Recently in the press PAS Deputy Dumitru Alaiba announced his initiative “KILL OFFSHORE” which would seek to limit the nefarious uses of offshore companies in Moldova by increasing transparency. 

So what’s the truth? Is offshore a terrible way for people to hide their money? Or a legitimate business practice?

The Problems of SRLs and Legitimate Reasons for Offshore

The idea of the SRL is inspired by the American Limited Liability Company (LLC) but in fact is a very different beast as we will see. But first, let’s get a few basics out of the way. If you’re interested in looking up any SRL in Moldova and seeing who owns it as well as various information about it there are some great sites to do so. Here are 2 examples:

Infobase - This site lets you look up SRLs, see their ownership, and see statistics about them including how much income and profit they make, how many people they employ, and more. 

Open Money - This site also shows ownership of companies but specializes in showing their records in public procurement tenders. One really neat feature is an interactive mapping of companies and ownership that lets you zoom out and see how companies are interconnected via their owners and administrators. The goal of Open Money is to allow the public and journalists to use this information to see if government officials hide behind multiple companies to illegally bid on tenders that they have power over. Sadly, this only gets you so far, as offshore companies are a kind of dead end since they don’t show their ownership in their home jurisdictions. 

If you bothered to follow either of the links above, you will see that I linked to the page on both sites representing my company “Smoke House SRL” which operates Smokehouse restaurant and Taproom 27 craft beer bar. You’ll see from the information page that I, David Smith, own only 1% of these companies in Moldova and that the majority owner, 97%, is by something called “The Moldova Company LLC” which is based in Virginia. So I myself am an owner of an offshore company doing business in Moldova. Let’s dig into why. 

How SRL’s Work

When anyone thinks of LLC’s in the US you probably have a few ideas jump into your mind. “Limited Liability” or protections for individuals from debt that their company takes on. “Pass through” which means that LLC’s don’t really pay taxes but pass the profits and losses through the company to the individual owners who pay taxes according to their own income brackets. And “flexibility,” LLC’s are really flexible structures that allow their owners to define all kinds of investment mechanisms and shareholder structures. Let’s take all 3 of these concepts with Moldovan SRLs:

Limited Liability - While it is true that limited liability is in the description of an SRL, it’s not very robust. The company “administrator” who is a kind of CEO figure, is liable for many company decisions and often has to personally guarantee company actions (though not always). Further, Moldova has a concept called “Statutory Capital” which is the amount of money raised through equity investment. The shareholders are liable for this amount of money and have to personally produce it if the company goes bankrupt. 

Pass Through - SRL’s are not pass through entities. They are taxed directly as companies on sales and profits. This concept doesn’t apply at all in Moldova. 

Flexibility - Here is the main issue. Moldovan SRL’s have extremely inflexible shareholder structures. When the company is founded the various partners put in their equity contribution in the form of statutory capital. The minimum investment for an SRL is 100 lei corresponding to 100% ownership of the company. So if Bob invests 40 lei and Steve invests 60 lei they own the company 40 and 60% respectively. At first glance, this seems logical. But problems emerge very quickly. Let’s take an example:

An Example to Attempt to Explain Statutory Capital:

Two men want to start a company. One, call him Bob, has $90,000 ($90k) to invest. The other, call him Warren, is an investment genius and has $10,000 ($10k) to invest. In America Bob and Warren could shake hands and agree that while Bob is providing 90% of the startup capital Warren is providing 70% of the value by way of his investment acumen. Therefore structure their company that way (Bob 30% and Warren 70%). In Moldova this is not possible because of the statutory capital problem. In Moldova Bob will have to create the company and then sell 70% of the shares to Warren for $10k. This $10k however, is in Bob's pocket not in the company. In order to put it back into the company Bob has 2 options. a.) Increase the statutory capital or b.) loan the money to the company for zero % interest. Option a.), however, is a problem because by increasing the statutory capital he is now diluting Warren's shares with his own money. Option b.) also has problems because the company's responsibility for that loan is different than the statutory capital investments (e.g. in the event of the company going bust Bob will get his $10k back first even though Warren owns 70% of the company). 

Basically, because shareholder ownership is totally designed by statutory capital you can’t create structures easily that account for “sweat equity” or other factors. Furthermore, and crucially, you cannot create more shares of the company. If you want to add an investor the old investors have to sell their shares as individuals and then somehow get the money into the company. There are workarounds, and most companies simply don’t do “equity” like we think of elsewhere in the world. They keep their statutory capital at 100 lei to indicate ownership and loan the money the company needs as individuals to the company. While this works for small companies, it totally precludes the rounds of financing and deals required to have an ecosystem like we see in tech hubs. Literally the entire scaffolding upon which company growth in the United States is built is simply illegal in Moldova. 

Conclusion: In Moldova SRLs are not good at protecting your liability and are totally unsuited to complicated shareholder structures or companies that want to grow via rounds of equity financing. 

It Gets Worse….

In addition to the comparison we made with more standard LLC’s above, Moldovan SRL’s are handicapped by other factors inherent in the Moldovan legal and financial system. For example:

Stamps and Signatures - Moldova is a very “paper first” society without a lot of online e-governance functions. The owners of companies are required to sign and stamp documents in person on a very regular basis. In the case of foriegn investors, not being in Moldova can be a serious problem as you will either need to travel to Moldova to sign useless reports, designate someone local to do it for you (giving them a lot of power), or sign the documents abroad, Apostille them (international notarization), ship them to Moldova, translate them, and notarize them again locally. I personally have known investors who have had to hop a plane from Belgium to Chisinau to sign a paper at a moment’s notice. 

Online Payments - Moldova is *very* new at online payments. There is no Stripe or Paypal in Moldova and accepting any kind of payments online is hard to manage. Because of this, many companies have to set up offshore if they want to process card payments or do business online at all. For example, when you use Yandex Taxi (Moldova’s Uber) your card is processed in Amsterdam. 

Facturas and Bon Fiscals - This is a hobby horse of mine so we’ll return to it soon for a full Deep Dive treatment. But basically, Moldova has extremely onerous paper-only regulations around receipts. So if you do manage to set up online payments through a Moldovan bank, you still have to provide a paper receipt. That might not be a problem if you are delivering a pizza - just send the receipt along. But if you are selling services or subscriptions where no physical delivery happens this can be a major issue. This is also true for companies that buy online services - for example Facebook advertising. It is extremely difficult to do this legally as Moldova does not accept digital (unstamped) receipts as justifications for company expenditures. At one point the Minister of Finance told me that the Ministry itself was unable to navigate the legal process of paying for facebook ads and needed to find workarounds. 

All these problems are what businesses call “friction” and contribute to wasted time and wasted costs. 

Conclusion - Why Legitimate Companies Offshore

So due to the frictions listed above, we can see that there are legitimate problems for Moldovan SRL’s. Let’s see how offshore fixes that. 

E.g. Fred wants to open a marketing company in Chisinau. His clients will be all over Europe and will pay for design services and consulting work. In order to get started, he needs investment and approaches friends and family for a seed round. But Fred eventually wants to sell his company to a larger group and exit his investment. Fred flies to the UK (or any other easy jurisdiction) and opens a company there. His investors (Moldovan or otherwise) invest in his UK company and gain share ownership there. Fred then uses his UK based LLC to open a Moldovan “captive” SRL. This SRL hires a staff and gets to work. When clients pay, the UK company bills them and they pay online - super easy! Fred then sends money to the SRL in the form of loans or service payments in order to pay the staff. The remainder of the income stays in the UK and that’s where Fred realizes his profits. Even if he was born in Moldova, and lived there all his life, Fred’s money isn’t coming into Moldova because of the structural issues inherent in SRLs. A few years later Fred takes on a new partner who buys 50% of his company and invests in growing it more. All this is done in the UK and could not have been done in Moldova. 

So we can see companies offshore for convenience, or to literally do things that are impossible under Moldova’s SRL law. It also helps that investors trust jurisdictions like the UK and US because they have functioning court systems. 

There’s one other factor driving this issue we have to discuss - the IT Tax law. Only a few years ago Moldovan IT companies largely operated in the shadows for all the reasons outlined above. Probably they had offshore entities but to save on income taxes (~40% in Moldova) they paid under the table cash to their local programmers and designers. A major reform now allows IT companies to pay a total rate of 7% of their income in taxes and avoid payroll and income taxes entirely. This brought the IT companies out of the shadows which is great! But as you might guess from what we’ve seen above, only just enough money to pay the employees and rent an office ever enters Moldova. All the rest stays offshore. So that’s not 7% of revenues, but 7% of Moldovan revenues. This is a great incentive to stay offshore or move there if you weren’t already. 

Ok, so what does this all mean really?

I know, this article has been really technical and we’ve been for quite a ride with the various parts of SRL laws and offshore companies. But at the end of the day, all this means is that Moldova gets a raw deal because it’s laws don’t work. Companies are driven to offshoring for totally legitimate purposes and this means Moldova realizes less in taxes and benefits from this work. It means that there can never be a “unicorn” like Facebook or Snapchat created in Moldova that actually legally lives in Moldova. 

And really importantly,  in a country where a small restaurant like mine needs to have an offshore entity behind it, you have a LOT of offshoring. This means that nefarious offshore companies (of which there are many) are lost in the weeds of all the legitimate and necessary ones. 

The bottom line is that SRLs are a mess. And because they are a mess lots of unintended consequences occur throughout the economy.