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Why Do Startups Incorporate In Delaware?

2 minute read
Why Do Startups Incorporate In Delaware?
Incorporating in Delaware is a popular choice for early stage, accelerated growth tech startups, particularly in the post-bubble era. There are certainly some downsides to incorporating in Delaware, including extra filing fees, the annual Delaware Franchise Tax, registered agent fees, and the additional costs of retaining a Delaware corporate lawyer in the event of a complex legal issue.

Reasons Why Tech Startups Incorporate in Delaware:

  • Establishing a US Presence. Some international ventures and non US residents prefer a Delaware Corporation to establish a US presence and have access to US resources, including US venture capital. US VC investors typically set standardized procedures for their investment activities and often require Delaware corporations for their investment targets (see more on this below). Note that you do not have to be a US resident to form a Delaware corporation. Read about this here: Can a Non US Resident Form a Delaware C Corporation? 
  • Delaware has the Court of Chancery, which is a special court that is dedicated to hearing corporate disputes. The state has a huge database of judicial precedent for corporate matters that are in the form of written opinions. The Court has no juries, business law is abundant, and judges are appointed on merit, not through elections. The corporation law that has been formed in Delaware is well known and often viewed as favorable to owners. Many corporate lawyers are familiar with the precedence set by Delaware corporate laws and courts in other states often look to well-established Delaware opinions for guidance.
  • Delaware laws tend to be pro-management and offer protection for board members from derivative lawsuits (lawsuits initiated by stockholders on behalf of the corporation). Under Delaware law, a stockholder must meet a series of prerequisites in order to satisfy the eligibility requirements in bringing the derivative action at all.
  • Delaware has several classes of stock and Delaware law gives preferred stock investors of a corporation certain voting rights and control over the corporation. Even though other states may also have different classes of stock, many VCs insist on the Delaware corporate form and will even require you to convert your current entity to a Delaware C corporation before they are willing to invest. This conversion (i.e. from a California corporation to a Delaware corporation) or re-incorporation will result in additional legal costs and may trigger tax consequences. It is important to do your research in advance in order to determine the proper state of incorporation at the outset, in light of your long-term fundraising goals.
  • Many companies that go public are typically formed in Delaware due to the flexibility and certainty of the laws.
  • Delaware permits a single-member board of directors, whereas California requires that the number of directors equal the number of shareholders up to three.
  • At a funding round, the California Secretary of State must review and approve filings before they are effective. Delaware, on the other hand, is not a review state, thus accelerating the funding process.
  • Delaware formations have become a staple among San Francisco and Silicon Valley law firms for accelerated growth tech companies. Standardization of corporate entities, founder stock purchase agreements, and investor terms in the tech industry has driven down the cost of formation and time for preparation of legal documents. In fact, a few of the larger law firms make some documents available to founders for free on their firm websites, though it is the responsibility of founders to then make the proper government filings on their own. Lloyd & Mousilli offers an automated Delaware filing option at a very competitive rate for founders.

In determining whether you should form your company in your home state or in another state, consider your long-term goals. It may be a good idea to gage the preference of your target investors so that you don’t end up creating more complications for yourself by embarking on a more creative, non-traditional approach. As always, if you have any doubts at all, make sure you consult with your Lloyd & Mousilli team of experts.

Reviewed By

Feras Mousilli

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