The Road Most Traveled: The Case For Incorporating in Delaware

We keep talking to you about hiring in the US, Taxes in the US … But what should you know when it comes to actually settle in the US: to incorporate? Today, our guest on ubi i/o’s blog is Francois Laugier from RMKB, an expert when it comes to incorporate in the US. He explains us why according to him, Delaware is THE place to be for your future corporation.

Some tech clients can be wary of taking the beaten path, and understandably so – in Silicon Valley, companies are encouraged to disrupt, not follow; to innovate, not replicate.  This leads clients, whether they are starting a new company, creating a subsidiary, or “flipping” from a European parent, to ask “Where should I incorporate?”, and then, “Why Delaware?” While it’s true that Delaware might not be for every new company, it is a great place to incorporate a tech startup.

Corporate Law in the United States

In the United States, the governments of individual states regulate the creation of corporations, and their governance.  Thus, for most corporations, state law will govern the formation of a new company, at least in part.

Generally, a corporation is governed by the laws of the states where it is “at home.”  This would be the state where it is incorporated, as well as the state(s) of its principal place of business.  For example, if Newco, Inc. is incorporated in Delaware, then even though its principal office may be in Silicon Valley, California, it is still governed by Delaware law. Then, depending on where it has its office and conducts its business, other state’s laws may come into play as well.

Incorporate In Delaware Because of the Favorable Legal System

One of the most popular reasons to go to Delaware is its corporate-friendly legal system. It all begins with the Delaware General Corporation Law (GCL), which is very pro-business.  Generally speaking, the GCL allows companies to handle their matters in a flexible, yet predictable way.  It also gives management a lot of control, more so than some other states (e.g., California, which gives more power to the shareholders).  As a result, many corporations have historically incorporated in Delaware, and Delaware has developed a comprehensive framework for deciding cases about the laws that govern these corporations.  All of this has helped make Delaware laws predictable, which is useful in operating a business, as it can help avoid disputes before they end up in litigation.

Additionally, while other states hear business cases in front of regular judges and juries, the Delaware Court of Chancery only hears business disputes.  Chancery Court judges are appointed on merit, so they tend to be more impartial and familiar with complex business issues.  This means that if a dispute does arise, your case will be heard by a real expert, and the dispute will likely be resolved quickly, reducing legal costs.

Incorporate in Delaware Because It Is Management Friendly

Delaware is also preferable because its laws often make it easier to complete corporate transactions that are common in the startup world.  As many founders know, corporations can have multiple classes of stock.  VCs typically take preferred stock, which gives them increased rights and voting power, while founders and other employees typically have common stock.  In Delaware, all stockholder votes are pooled, meaning a simple majority of the stock is required to approve significant corporate decisions – such as a merger or acquisition.  In contrast, California law requires a majority of each class of stock to approve this type of corporate decision, giving more substantive rights to dissenting stockholders.

So, for example, suppose you own Newco, Inc., and are in the enviable position of receiving a tender offer from a large company (we’ll call it MajorCo) to acquire NewCo.  Under California law, you would need approval of 51% of the preferred stock held by your VCs, and 51% of the common stock, which may be split among many people.  Under Delaware law, you would only need approval of 51% of all of the stockholders, including both preferred stockholders and common stockholders.  This means that there is less of a chance that you (or MajorCo) will get stuck buying out a dissenting shareholder.  Since Delaware requires you to jump through fewer hoops in getting approval for this type of transaction, you can focus on negotiating the deal – and you may be able to obtain more favorable terms from MajorCo.  For its part, MajorCo can rest easy knowing that it doesn’t have to worry about dissenting shareholders or whether you can get the approval of every class of stockholder.

Incorporate in Delaware Because VCs Prefer It

If you’re starting a tech company, you will almost certainly need to raise capital at some point, and this need for capital is a great reason to incorporate in Delaware from the start.  VCs are generally very wary of risk, and typically prefer to deal with things they can be certain about.  Because of Delaware’s historical significance as a location for new companies, and its predictable management-friendly laws, VCs simply feel more comfortable dealing with Delaware corporations, and will often insist on investing only in Delaware corporations (with a few exceptions – Apple, Inc. being a big one).  So by forming your company in Delaware, this can help streamline financing deals, and will save you the cost of having to convert your company to a Delaware corporation down the road – excellent reasons to incorporate in Delaware!

The Tax Myth

There is a prevalent myth that we hear from a lot of clients that they should incorporate in Delaware for tax reasons.  However, Delaware is not a tax haven.  This myth probably comes from the fact that Delaware does not tax corporate income earned outside of the state.  But unlike some other states which have no corporate income tax (Nevada or South Dakota, for example), Delaware does have a corporate income tax, and imposes an annual “franchise tax” on corporations which are incorporated in the state, but do no business there.  So you would still have to pay these taxes, as applicable.

So the bottom line is that Delaware is not the tax haven that founders sometimes think it is.  However, for companies that are not doing business in Delaware, the only tax that must be paid is the franchise tax, which is usually minimal – as little as $175 per year (if the corporation is set up properly).  Usually, this is not enough to dissuade founders from forming their companies in Delaware.

Conclusion

Nearly every company in Silicon Valley, and most of the Fortune 500, are incorporated in Delaware.  When it comes to incorporating your company, we generally recommend that founders take the road most traveled – as this road provides a flexible legal system, a management friendly approach, and is preferred by VCs.  So while we can certainly appreciate that you might be looking for a business adventure, we want to try to help you avoid an unnecessary legal adventure!

Now you know everything about Delaware regarding incorporation. But this exercise is way more difficult than a blog post, and you might have some questions or need some help. Well, we’re pretty sure than Francois Laugier and Jordan Beckerman will be delighted to address your concerns!

Francois Laugier; francois.laugier@rmkb.com; (650) 780-1691
Jordan Beckerman; jordan.beckerman@rmkb.com; (650) 780-1740.

Francois Laugier

Francois is a corporate transactions and international attorney who specializes in technology-related transactions while still advising clients in commercial litigation and dispute resolution.

Based in Silicon Valley for the more than 20 years, Francois helps entrepreneurs, investors and companies build, finance and sell their US or foreign operations, and get past every legal challenge they encounter along the way. He has handled numerous cross-border acquisitions and equity financings and brought many companies from their inception to successful exits for founders and investors alike. Francois advises companies in all aspects of corporate law, including entity formation, equity financing, technology licensing, corporate structure inversions (“flips”), mergers & acquisitions, joint ventures, stock options, employment, commercial leasing, intellectual property protection, negotiation and drafting of virtually any business contract.

François is admitted to practice in California, Washington D.C., and in the European Union. He is a partner, and an elected director of RMKB, a 100-attorney law firm with offices in California (4) New York (1) Boston (1) and affiliates in Paris and Hong-Kong. Francois was noted by the San Francisco Bay Area Lawyer Magazine as one of the “Top lawyers in the Bay Area” for mergers and acquisitions.  An advisor to the board of several technology companies, François is a guest lecturer on entrepreneurship, technology and international law.  He is also the regional President of the foreign trade advisors (“Conseillers du Commerce Extérieur”) to the French Ministry of Economy and Finance.

Francois graduated from Université de Montpellier and University of San Diego law schools.

By | 2015-12-21T12:08:45+00:00 May 29th, 2015|Advices|0 Comments

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