Why Do Startups Incorporate In Delaware?

If you’re based in another country or state, you might be wondering if there’s a reason to register your company as a Delaware corporation instead of just creating a simple LLC where you live. The short answer, especially if you plan on fundraising from VC firms or issuing stock options to employees as part of their compensation, is “Yes.”

Just a few years ago, I was helping a friend working on a startup building innovative developer tools which had incorporated a legal entity for their startup in their home city of Berlin.

Despite a tight pitch, great product, and solid founding team with past exits under their belt, it was almost impossible for them to raise funds as a German entity. Most tech investors didn’t even want to talk to them since they, as a rule, would not invest in German entities due to the “draconian bureaucracy” associated with investing in early-stage, private companies in Germany.

They were eventually successful in securing funding—after spending nearly $30,000 to incorporate in the state of Delaware and make their German GmbH a wholly-owned subsidiary of the newly-formed Delaware entity. Creating this new corporate structure was far more costly than simply creating a Delaware C Corporation to begin with.

Virtually every corporate lawyer, tech executive and VC in the United States is familiar with Delaware’s exhaustive body of business case law—and over two-thirds of all Fortune 500 companies are registered as Delaware C Corps for good reason.

In fact, one of the first questions that a venture capitalist will ask a first-time founder is: “Did you incorporate in Delaware?”. In this article, we’ll explain why Delaware is the preferred jurisdiction for many business owners, especially startup entrepreneurs.

• Filing Fees are low. It only costs $89 to file the articles of incorporation with the Delaware Division of Corporations, plus $100 or more for expedited processing. The incorporation process is fast and you can typically get your stamped certificate of incorporation back from the Division of Corporations in 2 to 3 business days.
• Delaware Corporation Search. Delaware secretary of state entity search has an easy online form to search existing corporation names in the Delaware company register. A company’s name must be unique and avoid conflicts with any existing companies already registered in Delaware.
• Tech investors understand Delaware corporate law. Making things easy for them will make things easier for you. Most law firms already have investment agreements and legal templates ready to go that work with business law in Delaware, so you save yourself on costs when raising money, too. Delaware state law is regarded as founder-friendly and has reasonable protections for investors as well.
• Minimum costs, maximum control. Delaware corporations are only required to have one director, which helps keep costs low and leadership consolidated. Compare this to California, which requires companies to retain two directors when they have two shareholders, and three directors when there are three or more shareholders. Unlike other states, Delaware does not have a stockholder-based requirement for the number of members of the board of directors.
• Easy to manage from afar. Businesses need only maintain a registered agent with an address in the state. There is no requirement to maintain an office or other physical presence in the state, and there is a well-developed service industry providing registered agents for nominal fees. It is easy to register a company in Delaware for non-residents and overseas founders who are not US citizens or taxpayers. You and your co-founders will never have to set foot in Delaware to run a company there.
• Privacy protection for company information. The names of officers and members of your board of directors do not need to be listed in the company formation documents on file with the state. Issuance of founder’s shares and other stock does not have to be disclosed publicly.
• Tax benefits. The Delaware tax payment is quite low. There is no corporate income tax if you do business in another state, and no personal income tax or tax on stock if owners live outside the state.
• A high volume of corporate transactions are executed there. Because of this, legal agreements and processes in Delaware are intimately familiar to investors, lawyers and most business executives. This can play a big role in making it easier to sell your company down the road, and, while founders may dream of making it all the way to IPO, M&A is the most common exit path for startups.
• The most robust corpus of corporate case law in the US. This ensures more predictable legal outcomes and better standardized documentation.
• A specialized Court of Chancery. This specialized Delaware court has jurisdiction over corporate matters, and the Delaware Court of Chancery is a separate court solely focused on the rapid resolution of business disputes.

If you choose to incorporate in Delaware, keep in mind that you will also need to register in every US state in which you do business—and likely your home state if you are based elsewhere—with a so-called Foreign Corporation Registration or Foreign Entity Registration, which grants your Delaware corporation the permission to do business in that state.

The company bylaws will typically authorize the board of directors and officers to obtain a company bank account and the required business registrations to begin business activity.

The process to do so is covered at length in the article Registering your Delaware C Corporation to Do Business as a Foreign Corporation. It is, however, possible to set up your business in other states and countries as a subsidiary of your Delaware C Corp to minimize tax liability, an idea we will cover in another article.

If you’d like to skip directly to the Instructions for creating a California registered agent, they are covered in the article Filing For A Foreign Agent Qualification in California.

As you consider a Delaware incorporation, it’s helpful to understand the methods underpinning the state’s franchise tax, which applies to business entities including both Delaware LLCs and corporations. Most corporations calculate their tax liability based on an annual flat tax and file a relatively simple Delaware annual report, covered in the article Delaware Franchise Tax, The Abridged Version.

This isn’t to say that registering elsewhere doesn’t have its appeal. Certain states, like New Mexico, Nevada, and Wyoming, have become popular with entrepreneurs aiming to keep personal information out of the public record. Others including Washington, Nevada, Wyoming, Texas, and Florida make a good case with very low or zero corporate tax.

When considering this issue, keep in mind the basic principle that where you incorporate is not necessarily where you do business. The aim should be to choose the jurisdiction that best meets the needs of your business and venture capital investors.

For tech startups, it’s simply very difficult to beat the overall advantages of incorporating in Delaware. The Delaware General Corporation Law is widely understand by startup lawyers as well as potential business partners and acquirers for your startup.

The rule of thumb is simple: if you think you’re going to have to incorporate in Delaware at any point in time, it pays to do it right out of the gate. I can tell you from personal experience that converting over to a Delaware corporation from another entity type is way more expensive than incorporating as a Delaware Corporation from day one.

Learn more about choosing the right business structure for your startup and whether a limited liability company or C corp is the right call. Both types of legal entity can be used to shield personal assets from legal liability, but there are huge tax ramifications as they are taxed differently.

• If you are planning on raising outside funding for your company, Delaware is an excellent choice of jurisdiction. Most investors prefer to invest in Delaware C Corporations, instead of limited liability companies.
• Most startup lawyers are familiar with Delaware law, making it easier (and cheaper) to get legal advice.
• 70% of Fortune 500 companies are registered in Delaware. Both large corporations and startups choose Delaware as their preferred jurisdiction.
• Delaware Franchise Tax is amongst the lowest tax rates in the US when calculated correctly. Even if a company authorizes a large number of shares, like 10 million shares or more, the annual franchise tax typically only comes out to a few hundred dollars.
• Delaware offers robust advantages for business from both legal and financial standpoints, including a separate corporate court system that resolves legal disputes efficiently.
• Registering elsewhere may result in the need to re-register down the road, which can be costly.
• After you incorporate, your startup will need to get an EIN from the IRS, which is a prerequisite to setting up a corporate bank account and getting ready to do business. Capbase simplifies the process of incorporating and scaling a startup with software to generate legal agreements, sign intellectual property assignment agreements, issue stock and stay compliant.