When it Comes to Incorporating Your Startup, Why Delaware?!?
Wednesday, February 11, 2015
When you're the second smallest state and your neighbors are NYC and Philly, you have to do something to stand out. So, when Calvin Coolidge announced that the "Business of America is business," someone in Delaware was paying attention. Since the early 1900s, Delaware has made the "business of America" one of its principal industries by providing the premiere venue for entity formation. According to the Delaware Division of Corporations, more than 50% of all U.S. publicly-traded companies and 63% of the Fortune 500 are incorporated in Delaware.
But why? What's the big deal? Well, a few things. First, the Delaware General Corporation Law is modern and flexible, constantly updated and improved by the state legislature, and interpreted and enforced by Delaware’s highly respected court, the Court of Chancery, which is dedicated to corporate litigation matters only. As such, it has become the "national" corporate law for many lawyers across the county who like its accessibility, predictability, and well-developed case law.
It's not without its costs, however. Incorporating in Delaware will typically cost you anywhere from $300-$500 annually, including state filing and registered agent fees, plus Delaware franchise taxes which can cost annually a minimum of $75 but will probably run you a few hundred dollars or even thousands of dollars (but don't let yourself get overcharged for franchise taxes; try the Assumed Par Value Capital Method for calculating your taxes). Compare that with Michigan which charges an initial filing fee of $60 and just $25 annually.
So, when is the additional cost worth the extra money to incorporate in Delaware? My rule of thumb is this: if you know that you will be soliciting venture capital within the next 12 to 18 months, go ahead and form a corporation in Delaware now. The corporation, specifically the C corporation, is the preferred choice of entity for venture capital. For tax reasons, the investors in venture capital funds prohibit the fund from making investments in any entity other than a C corporation. If the fund is required to invest in a C corporation, VCs prefer the benefits of Delaware (see above) for their investment. In addition, if the company and investors ever want to make an initial public offering (IPO), Delaware is practically the exclusive jurisdiction for IPOs these days. You can signal to your potential VC investors that you are sophisticated and well-represented by already incorporating your company in Delaware.
Not sure you will be taking VC funds and also keeping an eye on the budget? Then go ahead and file a Michigan LLC or corporation. If you do end up soliciting venture capital, the fact that you are a Michigan LLC or corporation will not be a deal breaker for VC. Moreover, it's easy enough to merge or convert your entity to a Delaware corporation as part of your equity financing.
Matt is a partner on the Business and Corporate Services Practice Team, and participates in both the Startup and Emerging Companies and Intellectual Property Practice Teams. His practice focuses on corporate formation and organization, venture financings, joint ventures, mergers and acquisitions, corporate governance, securities law, and intellectual property protection and transactions. He works closely with startups, second stage and private companies on day-to-day issues and all manner of corporate and intellectual property transactions.