13 Jan 2012

There are two states you should always consider when incorporating:

1. Delaware, and
2. The state where your business will be located.

Many startup lawyers will tell you that you should incorporate in Delaware. End of story.

I do not believe it is that simple. Delaware is a fantastic choice, but it comes with drawbacks. Similarly, the state in which your business is located may also be a great choice. Let’s look at both options in more detail.

Advantages of Delaware

1. Pro-business body of corporate law.
2. Disputes within the business go before judges who are specialists in business law rather than juries.
3. Investors may require you either incorporate or re-incorporate in Delaware anyhow.
4. Incorporating in Delaware may signal you are serious about your business and attracting investors.
5. Delaware has low incorporation fees.

There are other reasons why you should incorporate in Delaware. Ryan Roberts over at Startup Lawyer lists the top 5 reasons in his mind why you should incorporate in Delaware.  Brad Feld, a venture capitalist of some renown, discusses why you should incorporate in Delaware on his blog.

Disadvantages of Delaware

1. Registered agents—If your business is not based in Delaware then you will have to hire a registered agent service. This will be anywhere from $50 to $300 a year depending on the level of service you want and need.
2. Delaware franchise taxes—You will have to pay these. Some states do not have franchise taxes, but Delaware does. If you structure your company properly then these taxes should not be too high, but they are still another cost of choosing Deleware. Ryan Roberts discusses Delaware franchise taxes on his Startup Lawyer blog here.
3. Added administrative burden—You may have to register your company in your home state as a foreign company anyhow, and this will create two annual filing requirements. This creates an added administrative burden which may not be easily borne by a startup company trying to stay lean.

Why choose your local state?

1. Registered agents—Your registered agent can be someone at your company’s headquarters, rather than a registered agent service.
2. Possibly no franchise taxes—Many states do not have franchise taxes. Some may have franchise taxes, but this can be overcome by placing no par value on stock. This is one less bill to worry about.
3. You may have to register as a foreign corporation in your local state anyhow.
4. No good venture capital fund will choose not to fund a company because of where it is incorporated. The VCs can always require re-incorporation in Delaware as part of the funding deal

Grellas Shah LLP has a FAQ on Startup Law that discusses the question of where to incorporate. It provides some good insight into the factors the founders of a startup need to consider.

Conclusion

What do I recommend to my clients? It depends on where they will be seeking funding, how soon they will be seeking funding, and the costs they can currently bear.

If a client has the money to manage the expenses of a Delaware corporation, and they will be seeking outside investment soon, then I recommend Delaware.

If a client is cash-strapped, then I recommend their home state. Since I practice in Georgia, I end up recommending Georgia in these situations.

A quick note on Georgia corporations

Georgia is a good state in which to incorporate. While there is a publication requirement for Corporations, the filings may be done online through the Secretary of State website. Further, Georgia corporate law is modern, if not quite as Board-friendly as Delaware law.