Naomi Kokubo
Question: What are the advantages and disadvantages of incorporating in Delaware? I hear it’s important for an IPO, but if we don’t plan on going public anytime soon, should I bother to incorporate in Delaware?
Answer by Naomi Kokubo, Editor of Founders Space
That’s a really good question. We did some research and we found an interesting article on the advantages and disadvantages of incorporating in Delaware.
Here’s the key takeaway… “For the typical California-based early-stage startup, Delaware does not offer any practical advantages over a California incorporation. Perhaps the only near-term advantage is that Delaware allows for a single-member board of directors, regardless of the number of shareholders in the company. This can facilitate corporate governance in an early-stage startup. Apart from this, however, a Delaware domicile simply adds administrative burdens for an early-stage startup based in California. These burdens include the difference in the way franchise taxes are handled and the need to qualify as a foreign corporation in California. In general, there is more administrative hassle. The burdens can be dealt with, but the question is whether the burdens are worth the minor advantages, if any, afforded by a Delaware domicile in the early stage.”
See the full article on Incorporating in Delaware
I’m sure not every lawyer will agree with this article. It also depends on what state you’re in. Nevada is pretty friendly towards corporations. Keep in mind that the majority of corporate lawyers are well versed in Delaware law, so it’s much easier for them if you simply incorporate there.
Note: Before making any business decisions based on information on this site, it is your responsibility to check with your counsel or professionals familiar with your situation.
Founders Tip: Consider using a filing service such as Legal Zoom where they file all the documents with the state, get your record book, and more.
I agree with the answer. In my opinion, the major justification for forming a corporation in DE – one that does not apply to typical startups – is to minimize board accountability and liability to shareholders. Please see “Why are So Many Corporations Formed in Delaware?” at http://dana.sh/ayEmpH.
I'm afraid that I must disagree with the first paragraph of Mr. Stone's comment. In my experience, CA angels and VCs are quite willing to invest in CA corporations.
Disclaimer: This post does not constitute legal advice and does not establish an attorney-client relationship.
This is good advice with one caveat: If your business plan requires outside investment to get going, there's really no point in forming in California, since the first professional investor (including most angels) will insist on Delaware. Although changing a California corporation to a Delaware corporation isn't difficult, the cost of doing it will still probably eat up any savings you got from not incorporating in Delaware to start with. Depending on when people think of it, it could also complicate or even hold up closing on a round of financing. It will never be a major obstacle, but why not avoid the obstacle from the start?
Forming in California makes a lot of sense for a business located in California that is initially capitalized by the entrepreneur and/or friends and family and has a good chance of achieving positive cash flow without any outside equity investment.
It rarely makes sense for a California-based business to organize in Nevada (if you want to move to Incline Village or Reno, that's a different matter). You should deeply suspect anyone who tells you otherwise. A lot of people push Nevada incorporation with bogus claims of tax savings.
If you want more information on the benefits of Delaware incorporation, you might take a look at my comment on the answer to why VCs prefer Delaware incorporation on this site (https://www.foundersspace.com/fund-raising/why-do-vcs-prefer-delaware-corporations/).