When Delaware Incorporations Do Not Make Sense

One of the questions we get asked most often from startup businesses is whether to incorporate in Delaware or in the company's home state.  The answer depends.

There are many advisors who will tell you that to be a credible startup organization, you have to form your company as a Delaware corporation.  This is only partly true.  There are many reasons that serious investors want to invest in a Delaware corporation, but two, in particular, stand out.

First, the investors want the company to enjoy the company-friendly Delaware business laws and to have access to the unique, specialized business court in the state that has specific experience resolving business law issues.  Experience breeds predictability.  

Second, certain investors prefer the corporate form because of specific tax ramifications they face when investing through the limited partnerships behind many institutional and venture capital investors.  Flow-through entities like limited liability companies - popular with some new businesses - will simply not work for VCs. 

All that being said, new companies should make this decision based on what works best for that business.  Incorporation in Delaware also requires qualification in your company's home state, which means double filings and taxes, not to mention registered agent fees.  Plus, certain local state laws - such as employment laws - will apply to your business regardless of where you choose to incorporate.  And you can always reincorporate in Delaware should the need arise, but for many companies that decision is years away (if at all).  

In the mean time, you should start by analyzing your home state's law with experienced legal counsel and then determining whether the additional expenses of a Delaware incorporation now provide enough additional benefits to offset the costs.  If you are raising money with sophisticated angel investors, then the general rule of initially organizing in Delaware as a corporation taxed under Subchapter C of the Federal Internal Revenue Code is likely the most practical strategy. This is particularly true where the outside investors are located outside the state where you are primarily doing business. These potential investors and their advisors do not want to invest in a corporation subject to corporate governance laws with which they are not familiar.

If you are not seeking outside money, at least in the near term, then the "local option" may very well be preferable.