March 15, 2011 20 Comments
This one is easy, but bears explanation. Incorporate in Delaware. Period. Whether an LLC or C-Corp, go with Delaware. If your attorney does not recommend this to you, switch attorneys. If you tell them you read this when you are firing them, don’t let them give you a bunch of legal justification for whatever they recommended that was not Delaware, just walk away.
Or, before you walk away, ask your (soon to be former) attorney why 60% of Fortune 500 Companies, and 50% of publicly traded companies as well as 50% of all American corporations are based in Delaware.
So, why is little Delaware so popular? Several reasons.
First off, cost. Delaware is cheaper than most other states when it comes to incorporation fees. Others have tried to be competitive on this front, but they only compete on this first reason (read our post on not getting overcharged for Delaware Franchise Taxes – hint, opt for the Assumed Par Value Capital Method).
Next, while fees will seem important as you get started, this benefit will likely be far outstripped by the second one as your business grows. Delaware operates a separate court system (the Chancery Court) for general corporate law, and does not use juries in this system. This is usually a very good thing for corporations who do not want a jury deciding complex business issues, but would prefer it be overseen by a judge who spends all of their time dealing with corporate cases. Court decisions are written and well thought out, which makes them easy to follow in reviewing prior cases to understand how these may impact your business in the future.
Third, because of the number of companies that have incorporated in Delaware, the State has a large body of business law that can help as you grow your business while trying to avoid legal entanglements. In addition, the Delaware Chancery Court is considered one of the best in the country.
Fourth, because there are so many businesses incorporated in Delaware, and because this is a significant revenue stream for the State (30% of the state’s total revenues come from the Delaware Division of Corporations), they have invested in technology and processes to keep companies coming to their State. As a result, filings are usually handled quickly and you have the option to do rush filings on a number of important documents that can be helpful in a pinch, like when you want to close a new financing round.
Finally, on the legal side of things, most legal textbooks on business law draw heavily on Delaware court rulings because they are numerous and well written. As a result, most attorneys have studied a good deal of Delaware corporate law and deal with it on a regular basis (most of their clients are likely Delaware based, unless you have not fired the attorney as recommended in paragraph one).
The remaining reasons are less important, but worth considering:
(1) You do not have to live in or have offices in Delaware to base your Company there. While this is not a reason to incorporate there per se, it is important to understand as you read this article. You will essentially have a registered agent that handles filings for your Company in Delaware and will have the equivalent of a PO Box at that firm’s offices.
(2) If you are starting a small business, Delaware allows corporations to have only one person hold executive positions and allows for only one board member. This is generally available in other states as well, but a worthwhile consideration as you get your business rolling.
(3) You do not have to pay Delaware corporate taxes if your business is based there but you do not actually do any business in Delaware. You will pay franchise fees, as you would in most any state, but the taxation is favorable.
If you are sitting there thinking “damn, too late!”, don’t despair. If you just went through this process, give you’re attorney a chance to keep your business by having him start an entirely new entity in Delaware and deal with transferring any IP you assigned to the business across to it. If your business is already operating, talk with your attorney on this, but you will likely find it is a fairly expensive process to make the switch to a Delaware Corp., so you may need to consider whether it is worthwhile doing so, and whether this is the right time to do it (don’t forget, almost 50% of public companies are NOT based in Delaware, so all is not lost…).
We conclude with a note of caution (mostly to Delaware) on why this recommendation might change over time. It has become customary that every public company that gets acquired is sued (by the same handful of law firms in each case) based on an assertion that the transaction is not in the best interests of shareholders. This happens regardless of the valuation of the deal (it happened with 3Par and Isilon in 2010). Judges in Delaware have made statements recently that they would like to see these cases tried in Delaware courts (resulting in more fees and more case law). In an effort to encourage Plantiffs attorneys to files these suits in Delaware, there is concern that we will see favorable rulings for Plantiffs in what are widely considered to be nuisance lawsuits. We consider this a real negative and if this attitude continues in Delaware we may reverse our recommendation and highlight other states that are trying to compete for your business (literally). We see this as biting the hand that feeds the state because as mentioned previously, Delaware derives 30% of its revenue from its Division of Corporations, so to make life more difficult for these corporations by encouraging questionable class action lawsuits seems like a risky proposition. Stay tuned, but for the time being, Delaware still leads the pack.
(Note: A big thanks for our friends on the legal side for their significant contributions to this article!)