By Sutter Law, A San Francisco Business Law Firm.
Why Incorporate in Delaware
A critical question at the outset for new San Francisco Startups is what state they should choose for incorporation. This decision can have major implications for the advantages and rights afforded to the company as it grows. It also has implications in attracting investors for successful fundraising. Obviously, among fledgling companies, California is a popular choice. Nevada is also solid option for incorporation (this is why we’re seeing a surge in corporate communities in Reno and Las Vegas…think Zappos and Tesla’s battery factory). However, the debate ultimately boils down to Delaware or not-Delaware. And even then, there shouldn’t be much a debate. Most startups should incorporate in Delaware.
So why should San Francisco Startup founders put their babies in the hands of some small sliver of a state on the other coast? Because Delaware won the Race to the Bottom.
It should be noted that some perks of Delaware incorporation are actually universal to every state. Every state allows you to choose between perpetual and finite existence. Incorporators need not be shareholders. And every state carries a broad powers clause, which allows you to incorporate for any lawful purpose. But what more does Delaware offer to win the race to the bottom? Let’s examine the big ones.
Interaction with the State
Most importantly, Delaware has a robust and sophisticated judiciary, known as the Court of Chancery, in which only well-informed judges (not juries) hear only corporation cases. The Chancery’s business savvy has been honed over hundreds of years and is the envy of the country. It has rich and extensive case law on corporate matters, so if you do go before the Court you will have a good sense for how things will turn out (there’s a lower likelihood of litigation). Even when cases are appealed from the Chancery Court, the Delaware State Supreme Court is also known for expedited, knowledgeable and significant decisions rivaling the Court of Chancery. The court system, along with the state legislature, has a mandate to keep the State at the forefront of corporate law. These are the most compelling reasons to incorporate in Delaware.
Secondly, if you incorporate in Delaware, you’ll be interacting with the best run, most efficient and most personable Secretary of State’s Office in the country. The DE SOS, despite the volume of corporate filings they process each year, is not backlogged or inefficient as other bureaucracies are. And the actual process of incorporating your business is breezy: a single incorporator can incorporate (and do so anonymously); the incorporator need not reside in state (similarly, the shareholders, directors, and officers need not be DE residents either); and the board of directors can legally consist of just one director. The filing fee you’ll need to pay will be low relative to other states (like California).
The Standard for Investors
When negotiating with potential investors, the corporate structure should not be on the list of discussion topics. Both VCs and investment banks will simply expect that your corporation has been formed in Delaware. Traditional tech sector money is familiar with Delaware and feels safe in Delaware. In 2013 83% of all IPOs come out of Delaware. And the Secretary of State claims that nearly 65% of Fortune 500 companies are incorporated in Delaware. Nevada has corporate law that is comparable to Delaware (in fact, Nevada copies Delaware Corporations statute word-for-word), but Delaware remains the greater of equals because of its sage Court of Chancery.
The Structure of a Delaware Corporation
Within the nuts and bolts of a Delaware Corporate structure, there are several advantages for San Francisco Startups. Two general categories of these are listed below, but the underlying theme is that Delaware Corporate statute is flexible and affords the directors, officers and shareholders the most freedom to organize as they wish.
Director Friendly. Delaware is management-friendly, meaning a lot of power can be reserved for directors (as opposed to shareholders). California, by comparison, has the least management-friendly laws possible. If a certain power is not explicitly held by shareholders in Delaware, then the state will presume it to be held by the directors. DE permits generous indemnification provisions for directors and officers. It’s very difficult to pierce the corporate veil in Delaware, and there are notable restrictions on shareholder lawsuits against the corporation.
Taxation. While there is a franchise tax for all Delaware Corporations, the state does not assess corporate tax for those Delaware Corporations that conduct their business out-of-state. The corporate tax provisions for businesses working in-state mirror federal tax provisions, which makes filing really easy. Furthermore, Delaware does not assess taxes on shares held by non-resident shareholders, and there is no inheritance tax on nonresident shareholders.
Conclusion
There are downsides to incorporating in Delaware. San Francisco Startups, take note: if you incorporate in Delaware but conduct your operations in California, you will have to qualify as a foreign corporation doing business in California. This means you’ll have to pay annual franchise taxes in both California ($800 per year) and Delaware. Similarly, you’ll have to comply with reporting requirements for both states and maintain an agent for service of process in both states. Nevertheless, the advantages to incorporating in Delaware described above outweigh the burdens. It is always recommended to speak to a Business Attorney before incorporating your new company. For a free consultation feel free to reach out to Sutter Law to speak to a professional business attorney.
