Why Not Delaware?

Delaware is often regarded as the preferred state of formation for entities, but the advantages that Delaware provides may not be of value to your start-up.  Here are 5 reasons why Delaware may not be the ideal state of formation for your entity, at least initially:

  1. Subject to Other States’ Requirements. If your business is not located in Delaware, you will have to register your entity in the state where your entity principally conducts its business and potentially other states.  This means that you need to pay for a registered agent in Delaware and often you will need to pay for a registered agent in your home state if you will not act as the registered agent there. Your entity will also be subject to the reporting requirements of Delaware and the other states where your entity is registered, which will include your home state.
  2. Costs. Not all states have franchise taxes, but Delaware does:  Delaware has an annual franchise tax that is required to be paid by March 1 of each year for the previous year.  A Delaware company cannot make filings, including to amend its certificate of incorporation, effect a merger or even formally dissolve, unless it has paid its outstanding (including past due) franchise taxes.  A company that has not paid its Delaware franchise taxes is not in “good standing” in Delaware and will not be able to make representations and warranties to parties that it is in “good standing” (including delivering good standing certificates) until it has paid outstanding franchise taxes.  In addition, while Delaware does provide for expedited filings, these expedited filings cost extra on top of Delaware’s standard filing fees, so a start-up will need to budget extra money in order to make the standard, and any expedited, Delaware filings.
  3. Reputation May not Matter. It is true that many investors prefer Delaware entities, but starting off as a Delaware company from day one may not be necessary.  In other words, consider saving on registered agent, filing and franchise tax costs by forming your start-up company in your home state initially, and then be open to investors’ requests to convert or merge into a Delaware company when the time is right or when you have funds to cover those extra costs of being a Delaware company, which often is when you receive funding.
  4. Consent to Jurisdiction. Your Delaware entity will be subject to Delaware courts.  This means someone can sue your entity in Delaware, which may result in having to engage Delaware attorneys and travel to Delaware if the matter is litigated.
  5. Other States. Many states are not far behind Delaware in terms of services offered.  You should consult your local counsel to determine if your “home” state will provide similar benefits as Delaware.  And most agreements that your entity will enter into will have governing law and venue provisions that may provide for another state’s laws and courts to govern, so having a Delaware entity with its sophisticated legislature, laws and courts may be of no value when a dispute arises.

While you may be inclined to follow the lead of most Fortune 500 companies and form your start-up in Delaware, you should consider whether it is worth forming an entity in a state where you have no nexus, where it can be more expensive and where its advantages may not be applicable to your business.