When starting a new business, state of incorporation matters. The decision of where to incorporate can have long-lasting effects on your business’s success. In this article, we’ll explore the advantages and disadvantages of incorporating in different states, and help you make the best decision for your startup.
These general principles will help you understand which jurisdiction is the best fit for your startup’s unique needs. But remember, every situation is unique, so it’s best to work with your tax advisor and legal counsel to make your final decision. If you’re looking for counsel, feel free to reach out to us here.
If VC, Then DE
Here’s a simple rule of thumb for choosing which state to incorporate your startup in: If you’re raising venture capital (VC), then incorporate in Delaware. If not, then incorporate in your home state.
Why Venture Capitalists Prefer Delaware
Many people believe that Delaware is the preferred jurisdiction because of its low tax rate. However, this is not true. Here are the main reasons why venture capitalists prefer Delaware:
- Delaware Court of Chancery. The Delaware Court of Chancery is the preeminent corporate law court in the United States. Unlike other states, Delaware has its own special court system dedicated exclusively to corporate disputes. The judges are corporate law specialists, so their rulings are well-informed. Additionally, over the years, they have built up a significant set of case law, creating precedent for almost any issue that could arise. Investors’ counsel appreciates this because it increases certainty and reduces risk.
- Flexibility. The Delaware corporate statutes are clear, yet flexible. They enable companies to adopt provisions in their bylaws or certificate of incorporation that can help attract investors.
- Director Protection. Delaware has strong liability protection for members of the board of directors.
- Privacy. Delaware does not require the publication of shareholders or directors.
For these reasons, venture capitalists generally insist on incorporating in Delaware.
Incorporating in Your Home State
If your startup does not plan to become venture-backed, then keep it simple and incorporate in your own state. The costs of incorporating in a separate state generally outweigh the benefits.
- Taxation. Incorporation creates the legal entity, but it does not determine where the business is taxed. A company that is incorporated in Delaware but operates and earns revenue in California will be subject to taxes in California.
- Administration. When you choose to incorporate in a state that you are not based in, you increase your administrative burden and filing fees both at incorporation and on an ongoing basis.
For example, let’s say we’re launching a startup called Gregarious Games Inc. and it’s based in New York but chooses to incorporate in Delaware. After going through the standard incorporation process in Delaware, we have to file to qualify to do business as a foreign corporation in New York. That increases both time and cost at incorporation. Then, every year, they need to complete corporate and tax filings with both states. The company is spending more time and money for no real reason.
Instead, Gregarious Games Inc. would be better off simply incorporating in New York.
Tax Implications of Incorporating in Different States
It is important to consider the tax implications when incorporating a startup. Here are some factors to keep in mind:
- State Taxes. Each state has its own tax laws, including corporate income tax rates and sales tax rates. For example, California has one of the highest corporate income tax rates in the country at 8.84%, while Nevada does not have a corporate income tax. As noted above, a company will be taxed where the revenue is generated, not where it is incorporated.
- Federal Taxes. Regardless of where you incorporate, you will be subject to federal taxes.
- Franchise Taxes. Some states require businesses to pay franchise taxes or annual fees for the privilege of doing business within their borders. For example, Delaware requires all corporations, even those incorporated in Delaware but doing business in another state, to pay an annual franchise tax based on their authorized shares or par value of their stock.
Consider both state and federal tax implications when determining where and how to incorporate your startup. Seeking the advice of a lawyer or accountant who specializes in these issues can provide valuable guidance in making the best decision for your business’s financial health.
The Cost of Incorporation
Incorporating a startup involves several costs, including state fees, legal fees and other expenses.
- State Fees. Each state has its own fees for incorporating a business. These fees vary depending on the state and entity type chosen. Before beginning the incorporation process, research the fees for your chosen state and entity type. Some states also offer expedited processing options for an additional fee, which can be helpful if you need to incorporate promptly.
- Legal Fees. In addition to state fees, legal fees are also incurred when incorporating a startup. Have a lawyer review any incorporation-related documents and provide guidance throughout the process. Legal fees vary depending on your location and the complexity of your incorporation. Some lawyers charge a flat fee for incorporation services while others bill hourly. Discuss these costs upfront with any lawyer you hire to avoid surprises later on. At Westaway, all of our work is on transparent flat fees. If you’re looking for legal counsel, feel free to reach out to us here.
- Other Expenses. Launching your business may also involve other expenses, such as obtaining a business license or hiring a registered agent. Factor these costs into your budget when planning to incorporate your startup.
Incorporating your startup is an investment in protecting both personal assets and future business success. Carefully research costs, and work with knowledgeable professionals to make the best decisions for your startup’s financial health.
The Importance of Having a Registered Agent for Your Business
Incorporating your startup requires you to engage a registered agent. This is an individual or company designated to receive legal documents on behalf of your business, including service of process such as notices of lawsuits or subpoenas.
Having a registered agent is important because it ensures that you receive important legal documents promptly and protects your privacy by providing a separate address for legal correspondence.
In addition, some states require businesses to have a registered agent in order to incorporate. Even if your state does not require it, having a registered agent can provide peace of mind and ensure compliance with all necessary regulations.
When selecting a registered agent, choose someone who is reliable and trustworthy. Many companies offer professional registered agent services for a fee. Alternatively, you can designate an individual within your company or serve as the registered agent yourself (as long as you have a physical address within the state where you are incorporating).
Having a registered agent for your business ensures that important legal documents are received promptly and protects both your privacy and compliance with state regulations. If you’d like to learn more about registered agents, click here.
In conclusion, the state of incorporation is a critical decision when starting a business. If your startup plans to raise venture capital, incorporating in Delaware is likely the best option due to its favorable legal environment. However, if your startup does not plan to become venture-backed, incorporating in your home state is likely the simpler and more cost-effective option. Keep in mind the tax implications and costs associated with incorporation, and seek the advice of legal and financial professionals. By carefully considering all of these factors, you can make the best decision for your startup’s success.