To Delaware or Not to Delaware?-- that is the Incorporation Question

When setting up tech ventures or other businesses that require venture capital, the automatic assumption is that Delaware is the hip place to be. Sometimes, I am asked in lieu of the assumption, should the entrepreneur setup the entity in DE? As the first state in the union (let’s face it, other than that distinction DE is not a top tourist attraction,) DE needs something to keep up with the other 49 states. And that is its very advanced and now famous corporate law framework, which offers certain advantages over incorporation in other states. The usual suspects offered for this phenomenon should be kept in mind when you setup your entity. Not all states fit all needs.

If yours is a company that will likely have real corporate governance issues in the long run (read: shareholder suits, board of director power struggles, a national or international market, SEC issues, IPO hopes), DE might be the place. Delaware has a large and well honed body of business law to provide consistency and predictability. Other states can and often do deal with such issues on a first time basis, meaning their law is in flux. When you’re aiming to be the next Google, wondering what a Tennessee court that is less experienced (though I am not in any way suggesting less talented or bright) in these areas might be dangerous. In addition, certain specialty corporate litigation benefits from specialized courts without juries. For example, disputes over internal affairs are often filed in the DE Court of Chancery, which is a court of equity, meaning no jury.

Delaware is very outsider friendly and definitely makes it easy to have an entity without being in DE. For example, DE does not impose any residency requirement, but it does require that you hire a third party agent to receive service of process that is filed through the state (this can usually be cheaply acquired through services that specialize in this). Secondly, the DE corporate division processes administrative filings rapidly and cheaper than other states. And like New York, DE accepts faxes as legally binding filings, making filing and amending fairly quick and painless. Finally, if your company doesn't conduct business in Delaware, it will not be obligated to pay DE corporate taxes. However, it will be required to pay a franchise tax each year (think of it as a yearly fee).

Certain parties even demand that companies are incorporated in DE before going public, such as VC’s, etc. This is likely due to the long standing trend that public companies be formed in DE, coupled with a sense of security given DE’s pro corporate body of law.

No matter where you incorporate though, you have to bear in mind that you will have to comply with the local states in which you do business (tax, tort, contract, etc.) The internal affairs of the company may be governed by DE law, but that’s only one side of the coin.