Where should you incorporate your business – Delaware or California?
We recommend that you consider a Delaware Corporation as the first option, given the advantages that come from incorporating your company in Delaware. It is important to select the right state of Incorporation at the beginning so that you avoid additional complications and costs down the road.
This video explains some of the key reasons why you should incorporate your business in Delaware, even if your company is based in California.
Where should you incorporate your business – Delaware or California?
Where should you incorporate your business, Delaware or California? This is a very important issue that you need to get right so that you start your company with the right state of Incorporation and get it going down the right path.
When we set up new Corporations, we always start with the assumption that we are going to set up a Delaware Corporation. Even if your company is based in California or another state, there are significant benefits from using a Delaware Corporation, some of which we explain below.
First, Delaware is Investor friendly. Delaware Corporate Law and Delaware Corporations are well known and familiar to Investors. Delaware Corporations are considered the gold standard of Corporations. Investors understand Delaware Corporations and many times they will even require that a company be structured as a Delaware Corporation before they will invest their money. Also, by setting up a Delaware Corporation from the get-go and doing it right, you will avoid the extra complications and expenses that may result from having to reincorporate or move the state of Incorporation from a state like California to Delaware. So do it right from the beginning, especially if you are interested in raising money from Investors – set up the Delaware Corporation and get it on the right path to money from the beginning.
The next reason to incorporate in Delaware is administrative efficiency. Working with the Delaware Secretary of State is easy and efficient. Corporate filings are processed the same day, often very quickly. This efficiency helps facilitate getting transactions done and relieves the uncertainty as to the timing of when a corporate filing is going to be completed. There also are ways to expedite the corporate filings, such as same day, within four hours and other options. Working with Delaware is quick, easy and efficient, so if you have a company that will raise a lot of money or will be very transactional, a Delaware Corporation is the way to go.
Another reason to incorporate in Delaware is legal certainty. Delaware Corporate Law is well developed and predictable. With a Delaware Corporation, you will understand the consequences of making certain business decisions, and this well-developed corporate law will help guide your decisions going forward. Delaware also has a specialized court, the Delaware Court of Chancery, that focuses on corporate law matters. So if your Corporation finds itself in a situation where it needs to rely on some judicial decisions, you often times can work with the Delaware courts very quickly to get those decisions made.
Board of Directors
From a corporate governance perspective, there also are advantages to working with a Delaware Corporation. For example, if you have a business that is based in California and you decide to set up a California Corporation, there are some technical issues under California corporate law which determine how large your Board of Directors will need to be. With a California Corporation, if you have one Shareholder, then you can have one or more Directors. But as soon as you have two Shareholders or three Shareholders, you will need to increase the size of the Board of Directors. For a Startup that is working to raise money or working on launching a product, it can be a big distraction to have to worry about finding another Director or two that will mesh well and work well with you as the Founder.
On the other hand, with a Delaware Corporation, you can have one Director and many Stockholders. There is no requirement that the size of the Board of Directors increases as the number of Stockholders increases. This administrative flexibility and the ability to avoid the requirement of having to increase the size of the Board of Directors actually can be very beneficial. You can avoid a big distraction that I have seen play out with early-stage California Corporations that are raising money and increasing their number of Shareholders.
Another issue that you should consider relates to Stockholder voting. As an example, I would like to mention the approval that is required for a Merger transaction. Let’s say you start your company, you raise some investment money, you have Preferred Stock Investors and you have holders of Common Stock. You get to the finish line and you are going to exit your company and sell it to an Acquirer through a Merger transaction. Well, under California law, the Merger requires the class approval of both the Preferred Stock and the Common Stock, each voting separately. So imagine a situation where the holders of Preferred Stock want to sell the company, and the holders of Common Stock do not want to sell the company – you then end up in a situation where you will not get the proper approval of the Merger transaction.
Under Delaware law, the approval for the Merger is the majority of the outstanding stock, without the class vote requirement. Therefore, many Investors prefer Delaware Corporations because of the greater flexibility and the avoidance of the class vote requirement that you have under California corporate law.
Also, working with Delaware Corporate Law is more flexible than California corporate law when trying to get Stockholder approval on other matters. For example, Delaware Corporate Law provides more flexibility to obtain approval on paper by less than unanimous Written Consent, such as the election of Directors and other corporate actions that you may come across down the road with your Corporation.
Practical Tip 1: When to Use a California Corporation
Overall, there are significant reasons why I believe that you should structure your company as a Delaware Corporation.
However, if you have a California-based business, there may be some situations where it may make sense for you to set up a California Corporation. For example, you may have a closely-held business that does not need to take advantage of the legal and administrative efficiencies of a Delaware Corporation. Your closely-held Corporation may not expect to raise money from outside Investors or do a lot of transactions with third parties. In these cases, you just may want the benefit of setting up a separate legal entity for Limited Liability Protection, in which case it may make sense to go with a California Corporation and avoid having to deal with two states. Another reason might be pure economics – you simply cannot afford the additional Delaware Franchise Taxes, which at Startup typically range from $400 to $500. If you cannot afford this extra Delaware expense in addition to the California Franchise Taxes, then it may make sense to only set it up in California.
Practical Tip 2: “Quasi California Corporation”
As I mentioned above, I like setting up Delaware Corporations because of their administrative efficiency and the ability to know the consequences of what is going to happen with your Delaware Corporation.
It is important to note, however, that, even if you set up a Delaware Corporation, there are situations where California corporate law still might apply. Section 2115 of the California Corporations Code sets up what is called a quasi-California corporation – if your company has significant business contacts or operations in California, then some significant aspects of California corporate law will apply even though your company is set up as a Delaware Corporation (or a Corporation in another state). Recently, there has been some uncertainty as to whether this provision actually is legal, but, for now, you should assume that these quasi-California corporation provisions still apply and you will need to keep them in mind if you incorporate your business in Delaware or another state and your company is based in California.
Practical Tip 3: Foreign Qualification
No matter where you incorporate, whether in Delaware or California, or another state, if your company has significant operations in states outside the state of Incorporation, your Corporation may need to qualify as a Foreign Corporation in those other states. For example, if your company is based in California and you have set up a Delaware Corporation, then you still may need to qualify to do business in California as a Foreign Corporation, given that your Delaware Corporation is considered to be a Foreign Corporation for purposes of California corporate law. So, if your Delaware Corporation has significant operations in California, then it likely will have to qualify to do business in California as a Foreign Corporation. Likewise, if it has similar operations in other states, which are significant or trigger the foreign qualification requirements of those states, then it may have to foreign qualify in those other states as well.
In summary, when thinking about where to set up your Corporation, we recommend that you start with the assumption that you are going to set up a Delaware Corporation. Understand the key features and reasons why you should use a Delaware Corporation, and, unless there are financial or other important factors that come into play, set up your Delaware Corporation and get going with your business.
Please share with us how you have structured and launched your great business.