When launching your business in the U.S. there are some initial important decisions about your new U.S. venture to consider and formation is one of them. This includes deciding on what kind of company to form and where to incorporate it, if at all. You have undoubtedly heard that you “must” incorporate your company in Delaware. After all, Delaware is the number one choice for more than 60% of the Fortune 500 companies and they can’t be wrong, right? We have noticed though that there is a general misconception among Nordic startups about incorporation in Delaware so we are kicking off the first blog after a well-needed summer vacation with a dive into the mystery (?) of Delaware incorporation.
Misconception #1 – Tax Benefits
One of the main misconceptions about Delaware incorporations is that Delaware offers great corporate tax benefits to all companies. Yes, Delaware, like most other states, tries to keep its corporate tax rates low to stay competitive but taxes are not the reasons why Delaware is popular. Income taxes are paid on several levels and a company typically pays federal, state and local taxes. The state taxes are based on where the company has so-called “nexus”, i.e. presence, and not which state it is incorporated in. In short – taxes are paid where the money is made. Most companies establish and run their business from another state than Delaware and unless you’re operating your business actually out of Delaware, Delaware state corporate tax rates will not apply to your start-up. Yes, you will have to pay a franchise tax to the state of Delaware if you incorporate there but it is not to be confused with the nexus income state tax, which is the main state-related tax a corporation needs to pay.
What about online companies you might ask. Well, as long as someone who is working with the company is physically located in any of the states in the U.S. this person’s home address will likely become the corporate tax nexus for the company, even if the person is only a contractor. For truly foreign companies who are operating from a foreign country, the situation may be different so make sure you understand how tax nexus affects your business and presence in the U.S. by discussing your situation with an attorney.
Misconception #2 – Delaware Is For All Companies
Another misconception among Nordic entrepreneurs is that all companies should “incorporate” or “register” in Delaware. To understand this misconception, you need to know more about the different types of business entities you can operate as in the U.S. A limited liability company with foreign owners is typically set up as either a C-Corporation or a Limited Liability Company (LLC) but the two business types have different formation requirements and only Corporations are in fact incorporated in a particular state – LLCs are formed and registered in a particular state but not incorporated. Also, depending on your business goals and plans your company might not need to be registered or incorporated in Delaware and this is especially true for LLCs. As mentioned above, unless you intend to operate from or in Delaware, Delaware is probably not the right fit to be the home state for your LLC as you will have to register in the state where you intend to conduct your main business on top of registering in Delaware. So, for example, if you plan to do business mainly from an office in California but choose to register your LLC in Delaware, you will still have to register the LLC in California as a foreign company, i.e. foreign to California as your primary state of registration is Delaware. In addition, you will have tax liabilities in two states, dealing with the headache to maintain two LLCs, pay for an additional Registered Agent (part of the formalities is to maintain a Registered Agent in each state where you are registered as an LLC) and pay annual reports in two states. For some businesses this double headache is unavoidable and for the majority of tech companies who are interested in attracting institutional investors and having the ability to set up employee stock option plans, forming a C-Corporation is a must and Delaware is where you will most likely head to.
Why Delaware?
Delaware is the second smallest state, only Rhode Island is smaller, and Delaware is the home to about 1 million people. So why Delaware you might think. Well, Delaware figured out some 200-years ago that positioning themselves as the best state in the U.S. to incorporate a business was a good differentiator for a small state to have. They started forming business-friendly corporate law and realized they could capitalize on the structure to grow an important income for the state. It proved to be successful and incorporating in Delaware is now the golden standard for many companies.
Best Court System and Smartest (?) Business Lawyers. Delaware’s court system, the Court of Chancery, is the oldest business court in the U.S. and has the deepest case law and most efficient process for business law cases. Rumor says the state attracts the smartest and most passionate corporate and business law scholars and lawyers in the country law as they want to work with the most sophisticated business law system in the U.S and with other smart lawyers who share the same passion for evolving corporate law into statutes adapted to modern corporate law. With specialized lawyers, you can be sure that if you take a business issue to court in Delaware the judges will understand your issue. Whereas if you litigate a business issue in a California court your judge’s last case could have been family law and tomorrow, he will be doing real estate law. Needless to say, litigating in front of a judge who is experienced in and understands business and business law could be the do or die for your business. Also, in Delaware, a judge, and not a jury, will hear your case which means that there is more legal certainty about how the courts will treat certain contractual and transactional issues.
Speed. The Court of Chancery is known for resolving cases quickly and even appeals to the Delaware Supreme Court can be expedited. A speedy trial saves the litigants both time and money.
Well Developed Corporate Law. With so many smart lawyers in one place and a court that specializes in one legal area, you can be sure that the court applies the most groundbreaking, established and current case law to govern the outcome of the cases it hears and the case law it produces. There is probably no other court in the world whose decisions have so much legal power over both domestic and global businesses. Moreover, Delaware’s corporate law is so well established that many other states are copying it to include less regulation and more flexibility in an attempt to appeal to corporations in their home states. The extent of this is yet to be seen but Nevada is a serious competitor to Delaware looking to get a piece of those revenues Delaware is today collecting as a result of its well-designed business court and regulatory climate.
Investor Expectations. Delaware corporate law is widely taught in most law schools in the U.S. and the majority of lawyers in the U.S. know Delaware corporate law better than the corporate law of their home state. Investors all around the U.S. are also familiar with the Delaware system. The investor’s familiarity with Delaware law may make them more likely to invest in a Delaware incorporated company because they know all about the legal framework and limitations that govern the work and duties of the Board and CEO of that company. They probably know it far better than the Board itself and the CEO. If you mess up as a Board or CEO, your investors know exactly how to get to you and it is all about protecting their investment and familiarity with the law is a very important factor for investing.
Incorporating in Delaware Is Easy. Delaware is known for being a business-friendly state with laws that are flexible for founders and shareholders. Their office is not as bureaucratic as other government agencies and offers generous opening hours and you can form a company in as little as a few hours in some cases. In California on the contrary, it may take several weeks and the administrators are not as service-minded meaning that they might send you a snail-mailed formal letter for a matter that would take them 30sec to resolve over the phone.
Privacy Protection. Companies incorporating in Delaware can enjoy greater privacy protection than in several other states because Delaware does not require to disclose officers or directors in the official formation documents. For board members and directors who want to operate without being easily found in public records, the privacy protection is a valuable regulation.
To conclude…
…if you are aiming to raise capital to scale your business, a Delaware corporation is almost always the smartest choice when starting a business in the U.S. Investors in Silicon Valley meet hundreds of companies on a yearly basis and incorporating in Delaware signals that you are serious with your business and that you are ready for their money as soon as the ink dries on those investment papers. If you’re bootstrapped, you can start up as a California LLC and then transform your business from an LLC to a Delaware Corporations. It is a straight forward process but it takes time and money so you might not want to take the risk of letting your investor wait for that process. Be smart about your decisions and as with everything there are exceptions and tax implications so take advice from a lawyer before deciding what is best for your company.
