According to the State of Delaware, more than two-thirds of Fortune 500 companies are incorporated inside its borders (as Delaware C Corps). This trend is not limited to big corporations as many small businesses and start-ups make the same decision. Even in Silicon Valley, establishing a new company in Delaware has become the new norm. In this post we break down why companies choose Delaware as their state of incorporation, and whether this is the right move for your business.
The Benefits of Incorporating in Delaware
The Delaware Court System
Delaware’s Court of Chancery is well-respected for its handling of business cases for both small companies and larger corporations. While other states may use either judges or juries to decide business-related cases, Delaware’s court uses only judges, ensuring a legal decision from someone experienced and well-versed in a variety of business scenarios. With the state’s vast catalog of previous decisions, companies usually have good foresight into how cases will turn out, which can promote settlements.
The state’s court system is also well-known for being favorable to business owners – only increasing its reputation among those deciding on where to incorporate. Board members especially have benefited from the state’s protection against derivative lawsuits (lawsuits brought by a shareholder on behalf of a company).
Venture Capital Preference for Delaware
Not only do investors prefer companies established as Delaware C-Corps, but sometimes they even require it as a condition of investment. Most VC firms and their lawyers are already familiar with the Delaware legal system, and are comfortable with the mechanics of complex transactions in the state.
Flexibility and Privacy
Delaware offers a great deal of leniency in terms of structuring boards of directors and issuing stock. Unlike other states, Delaware gives preferred shareholders of a company greater voting rights and influence over the business. Further, directors, officers and major shareholders are not required to be residents of the state.
The process of forming a business in Delaware is easy when compared to the process of forming a business within a different state. One can form a corporation in Delaware by filing online paperwork which can be formalized in a matter of hours. Companies are also not required to disclose information about their founders or directors on their formation documents. In other states, these documents require heavier disclosure like providing at least three people holding the director position and another three holding the officer position.
One other reason businesses decide to incorporate in Delaware is its tax breaks. Companies that are incorporated in Delaware, but do not conduct business there are not subject to state corporate income tax. Major shareholders are especially fond of the state’s policy of not taxing stock shares if owners do not live in Delaware.
Additional Taxes and Fees
While companies that don’t do business in Delaware aren’t subject to state income tax, they are subject to franchise taxes. In addition to the franchise taxes in Delaware, a company will also have to pay these taxes in the state where its headquarters are physically located. The Delaware version of this tax can add up quickly – costing a company anywhere from $125 to $180,000.
Even though the process of establishing a business can be quick and easy in Delaware, it is also more costly. A newly formed company can expect to pay $1-2K more in filing fees than they would in other states. In addition to this filing fee, a company will have to pay foreign qualification fees to do business in its home state. If Delaware is not the actual home of your business, the company is also required to hire a registered agent with a Delaware address to receive legal documents on behalf of the company.
If your business is small, and not planning on acquiring VC funding, it may be more beneficial to incorporate in your home state to avoid these fees. Delaware courts also take an expansive view of who may be subject to their jurisdiction. So, even though your only contact with Delaware may be as the state of incorporation, that alone may be enough to subject your company, and its officers and directors, to suit in Delaware.
Making the Right Choice for my Business
Forming a corporation is a giant step in the life of any business. For those unsure whether incorporating in Delaware is the right decision, it is recommended to consult with a legal team well versed in the business laws of the state. For some smaller companies, the legal and financial incentives of incorporating in Delaware may not be as valuable as they would be for larger corporations. A founder should also consider not just what will work for their business today, but also what decision will be in best interest of the business for the foreseeable future.