Dear Alex:
I am starting a new business, and a friend told me I should incorporate in Delaware. I’ve heard this before but do not understand why this is recommended.Do you think I should form a Delaware corporation?
It is true that many companies choose to incorporate out of state, in more “business-friendly” states such as Delaware or Nevada, and for a variety of reasons.
For most small businesses in California, however, incorporating out of state is an unnecessary inconvenience and complication to conducting business. For some business types, however, it may make sense and might even be critical to the future success of the business.
Frequently, people tell me they want to incorporate in Delaware for “tax purposes.” While Delaware’s franchise tax is frequently lower than California’s minimum of $800 per year, foreign corporations doing business in California must still pay the $800 franchise tax to the state of California, as well as other registration fees.
Moreover, even if the out-of-state venue in which you elect to incorporate has friendlier tax policies, California’s State Board of Equalization is highly proficient at collecting tax on foreign corporations doing business in California, for all of their California business activities – just as if it were a California corporation conducting such activities.
Unless the corporation has a significant amount of out-of-state revenue generation and business activities that are not managed or the result of work performed in California, your business is unlikely to find any tax haven by incorporating out of California.
Another viable reason for incorporating in Delaware is due to the body of law that Delaware has developed for their corporations, and the protections Delaware law offers to business management and directors.
Delaware has a long history of being a desirable location for corporations to form, and as such the state has developed a significant body of law that provides predictability and protection for the business owners. This is also desirable for a large company; however in a small-to-mid-sized business in which the owners are also frequently the only shareholders, this is of little value.
The most compelling reason for a small California business to incorporate in Delaware is often for the sake of appealing to financiers from venture capital and angel investment firms. Small businesses structured to grow via funding frequently incorporate in Delaware to appeal to venture capital firms.
Venture capital firms desire the benefits of Delaware’s body of corporate law; they prefer to keep consistent applicable laws across their entities to the extent possible to more readily stay in compliance with those states’ laws; and if they anticipate the company may file for an IPO in the future, at that stage Delaware’s combined benefits may become very important.
For your small business, however, unless you are a startup intending to seek rounds of venture funding, Delaware may not be as desirable as it is frequently made out to be.
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