Which State Should You Incorporate In? Delaware.

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!)

Author: CapGenius

All about equity

26 thoughts on “Which State Should You Incorporate In? Delaware.”

  1. Thanks for this info – I was trying to understand why our lawyer said we should consider Delaware since we do not live there, have never been there, and doubt we’ll do any business there! Now I get it.

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    1. My simple explanation is that Dana is an attorney based in California who also has a strong bias for forming CA entities. The majority of attorneys who work with venture-backed startups, including those based in California, do not typically recommend incorporating in this state. The arguments he makes are more applicable to small companies that do not expect to have a broad footprint. He will disagree with this assertion (check out Quora for some back and forth on this) but the reality is that most of the top law firms working with entrepreneurial companies will recommend Delaware with a view towards the long-term future of a company as it grows (see note on % of public companies in the US that are incorporated in DE).

      1. My bias is not to form CA entities. I have formed many entities for clients in DE as well as in CA and other states.

        As I explained in my post at http://danashultz.com/blog/2011/07/01/in-which-state-should-my-startup-incorporate/, my approach is “Incorporate in the state in which you are doing business, unless there is a good reason to do otherwise [in which case the other state chosen probably will be Delaware].” A “good reason” is that one expects to receive an institutional (such as VC) investment.

        My major concern is that too many naive entrepreneurs form entities in DE (or NV) without exploring whether and why that might be the right, or the wrong, choice. In any event, I disagree with this post’s assertion that every entity should be formed in DE.

      2. My bias, actually, is toward forming entities in the jurisdiction where they will be doing business. As is noted on http://danashultz.com/blog/states/, I have formed many entities in DE and CA, and a number of entities in other states, as well.

        As I wrote in “In which State should My Startup Incorporate?” (http://danashultz.com/blog/2011/07/01/in-which-state-should-my-startup-incorporate/), based on the clients I serve: “Incorporate in the state in which you are doing business, unless there is a good reason to do otherwise [in which case the other state chosen probably will be Delaware].”

        An expectation that one plans to to seek institutional (such as VC) investment is an example of a good reason to choose DE.

        For reasons explained in my post cited above, I disagree with this post’s statement that every corporation should be formed in DE. And I don’t know why this post would apply that recommendation to LLCs, with respect to which DE’s leading role in corporate law does not apply.

        As concerns “top law firms”, readers might be interested to know what an individual who spent several years with one of those firms revealed to me after leaving it: The firm routinely told clients to incorporate in DE because the firm then could assign any corporate lawyer in any of its US offices to do work for any of its corporate clients.

      3. Highlighting this because if it is not clear to people reading our posts, we are very much focused on companies planning to raise institutional capital (usually venture capital) and scale to massive heights, hence the DE reccomendation.

    1. To be honest we are not as up to speed on Nevada – heard some reasons why this is a decent option but there are other states also trying to compete with DE. Question is whether they will stay consistent with this focus or not, combined with the fact the DE courts have a much clearer history of case law for businesses (given the number of companies incorporated there)

  16. Thank you for the great post! If my business will be online and at a physical retail location (in CA), how would you compare the benefits of incorporating in DE (and subsequently having to register in CA given my store) versus just incorporating in CA (so I only have one state to worry about for reporting, etc..)?

    1. Delaware is still a better bet because the laws of that State will apply. That said, depending on your goals for the company (long-term size), going the DE route may be more work that it is worth.

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