(Updated June 14, 2017)
If you’re in the startup world, you may be at least vaguely aware that most hugely successful startups are Delaware corporations.
Indeed, there are many smart people who say this is the only right answer to the question, “What type of entity should I form for my startup?”
I don’t think this is true, however. There are many different types of companies. And different structures make sense for different companies with different plans.
Forming a corporation in Delaware is not for the benefit of the founders. It’s for the benefit of investors. And that’s fine if your investors are going to be writing, six-, seven-, or eight-figure checks to fund your growth. But if you don’t plan to bring on investors, or if your investors don’t care whether you are a Delaware corporation, then you probably shouldn’t either.
There are many reasons to start your corporation in Delaware. But for most companies, forming in Delaware only makes sense if you have a real chance of obtaining VC funding. So, if catching the fancy of Peter Thiel and Brad Feld is important to your growth and development, then yes, no debate, go to Delaware. But if it is not, you will save money (approximately $600 a year by starting your business in Colorado), time, and hassle by sticking closer to home.
Here’s a quick list of reasons why someone might want to incorporate in Delaware.
- Forming a Delaware C Corporation is a form of “signaling.” It’s a way of saying to sophisticated investors, we know the type of entity you prefer to invest in, and we are already that type of entity. See, we’re ready for investment!!!
- Many VCs won’t consider any other entity.
- If you’re looking to join TechStars, YCombinator, Founders Institute, Boomtown, or most of the major accelerators, it’s either Delaware C Corporation or the highway. That said, we did work with one major California accelerator that let a company we represented remain a Colorado corporation. So if you’re looking to join a lesser-known accelerator, some of these might be more flexible about company domicile, as long as your corporate structure is otherwise in order.
- Delaware corporate law is the most predictable of any state. The state has a “Court of Chancery” that handles all disputes related to business outside of tort and criminal law. This has made them the go-to hub for corporations. With over 200 years of precedent on every major issue, judges handle most issues quickly and with greater alacrity than you might find elsewhere.
- Most lawyers who are well versed in corporate law know Delaware law, which eliminates needless research costs.
- No juries = lower volatility risk in judgment awards.
- Delaware has no sales tax, income tax, or property tax for non-residents.
- Delaware managers may remain anonymous if they so choose.
- Delaware has considerable contract law protections and pro-business precedent in case law.
But there are disadvantages to incorporating in Delaware, as well.
- It’s more expensive to register and maintain a business in Delaware than in your home state (and very much so in Colorado).
- Even though it is now 2017 as of the time of this writing, Delaware still, for some reason, requires all filings to be handled by fax machine. It then takes one to two weeks for those filings to become effective (unless you’re willing to pay for expedited service). The technical end of the Delaware filing process is downright archaic.
- In Colorado, it costs $50 to register a corporation with the Secretary of State with a $10 annual fee every year thereafter.
- In Delaware, all filing fees are much more expensive, you are required to pay an annual franchise tax, you must hire a registered agent in the state, and then you are required to file as a foreign entity in Colorado.
- Want to learn about the assumed par value method? You will if you incorporate in Delaware.
- All told, depending on your business, you’re probably going to end up paying 10x as much in the first year to incorporate in Delaware, and a much, much higher multiple every year to be in Delaware thereafter.
- The odds of having a shareholder suit in the first few years as a fledgling corporation are infinitesimally small, so the benefits of being a Delaware corporation are unlikely to benefit you, at least in the first few years.
My formula is this: If you have a realistic chance of obtaining VC money or sophisticated investor funding in the first 24 months, register as a Delaware C Corp right away. Or, if you’re involved in complex corporate transactions where corporate liability is an issue, you should also incorporate in Delaware.
If those scenarios seem unlikely to you, then go ahead and register in your home state as a corporation (if you’re in a business friendly state like Colorado). Get your capitalization structure set up right from the beginning. It’s ok to keep things relatively affordable at the outset and not to put pressure on yourself to take VC money before you’re ready.
Then, if and when you get serious investor interest down the line, you can always convert to a Delaware C Corporation later. With the enactment of Delaware Code Section 265 in the middle of last decade, conversion to Delaware is not as complex as it once was. (Caveat: This is true in Colorado. For other states, such as New York and California that do not allow for statutory conversion, this is not necessarily true. And this does not mean you should ever try to handle the statutory conversion without legal assistance. There are always significant legal considerations when converting a business.).
But when you are ready to convert, since you’ll be doing it at a time when you know you have serious investment interest, you won’t have to worry about whether you’re dedicating your precious startup resources to the wrong place.