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.

HotOrNot? for VC's--TheFunded.com

I often get asked by my clients about how the various venture capital players stack up against each other. It is a difficult question to answer as so many of my clients have differing needs, personalities, and subjective lenses through which they see the startup world. Luckily, the web has provided a solution through social networking and snarkiness. In early 2007, Adeo Ressi took the HotOrNot lens to VC’s, by providing entrepreneurs the opportunity rate and often rant about their particular VC experience on TheFunded.com.

That in itself is threatening to VC’s, which are a selective and secretive lot. In a recent move, registered entrepreneurs can post and share VC term sheets for an added dimension of being in the know. As any entrepreneur familiar with VC’s knows, the term sheet is the ultimate forensic tool for piecing together the scene of a deal.

As one can imagine, the VC’s have been subject to all manner of perceived libel and are probably not thrilled at the prospect of being ranked or scrutinized. The site’s goal of ranking VC’s is a bit of role reversal, but in the end, with proper discipline among its membership it can prove to be a very valuable tool. In his Wired interview, Ressi claims his site is designed to properly channel VC’s into: “backing savvy entrepreneurs to move the fundamental technologies of humanity forward.” Well, Adeo if the site simply provides a real forum for open discourse on the subject, then I think I will be happy with that.

Forming New York Professional Entities

A New York professional entity (PLLC, P.C.) is a unique intersection of the business law and the licensed professions. In short, if you are a licensed professional in New York State, through the New York State Department of Education, (e.g., doctor, architect, etc.) and you with to open an entity to do business, then you must establish a professional variant of the standard LLC or corporation (hence P in PLLC or the P in P.C.). Under Section 6507 of Title 8 of New York State Education Law, the Department must issue Certificates of Authority to any professional seeking to organize an entity under Section 1503 of the Business Corporation Law. The “Certificates” certify “that the individuals organizing the professional service corporation are licensed and currently registered to practice in their respective professions. Hence, before you get the blessing from the Department of State for your entity, you have to go through the Department of Education.

The interesting thing to note that if you want to provide your special brand of services to the public, you can do so without opening an entity as a sole proprietor (meaning no business entity, just you and the public). However, the very nature of most professional services means tremendous personal liability and a maze of malpractice issues. So in the end it’s a checkmate on the chessboard of options. In any instance where there is a high level of malpractice liability, an entity is the first best level of defense. Hence, those individuals must almost always seek to organize as a professional entity. Of course, the standard array of malpractice insurance must also be acquired, but having an entity to render services through and enter into contracts on behalf of you is highly advised.

Opening a PC or PLLC is not any more difficult than opening the standard LLC or Corporation, but requires a letter to the Education Department requesting a Certificate of Authority with an attached copy of the formation papers for the proposed entity. Once that certificate is acquired it is submitted to the Department of State with the formation papers. Although, as with all such matters, it is best to consult an attorney.