What’s the Advantage of Incorporating a Startup in Delaware for a Closely Held Company?

We often advise our users on LawTrades how a company should be structured is something that needs to be carefully considered as part of a legal consultation because a business lawyer is going to be able help you identify potential blindspots. With that said, I find that most of the time, the best state in which to incorporate the future entity is the home state.

As others have correctly commented, many people incorrectly assume that Delaware is the best state in which to incorporate when that is often not the case. It could be depending on the nature of your company, but it often is not the best option.

Delaware is certainly well-developed and favorable toward corporations. This is reflected by lawyers across the country who seem to boast a fairly universal knowledge of Delaware corporate law. At the same time, this is often because state corporate law – particularly the further west you go – is often modeled after Delaware corporate law. There are other advantages to incorporate in Delaware:

  • Delaware is attractive if you plan on raising capital through multiple financing rounds. Venture capital firms and investment banks ordinarily require startups to incorporate in Delaware for a host of reasons, including limit on liability for directors and officers.
  • Delaware General Corporation Law provides a ton of flexibility for businesses to carry on their business in ways disallowed in other states.
  • Delaware provides strong privacy protection for shareholders and directors.
  • Delaware has Chancery Courts that specialize in corporate law without requiring a jury. The State of Delaware website provides that “Delaware’s judges are impartial and not beholden to special-interest donors or shifting political winds. Unlike in many other states, Delaware corporate law cases are tried exclusively by professional judges, and not by juries.”
  • Delaware is not cheap when it comes to providing customer service. The State of Delaware website states that “Delaware’s Division of Corporations is open 15 hours a day to accommodate requests for filings from around the world; it offers specialized and expedited services (including one-hour, two-hour, and 24-hour service) for urgent and time-sensitive matters. The Division of Corporations, in conjunction with expert Delaware lawyers and experienced supporting businesses such as Delaware registered agents, can handle nearly any situation.”
  • Businesses incorporated in Delaware are not required to have an office there (but you will need a registered agent). Also, companies that do not conduct business in Delaware do not have to pay sales tax, corporate income tax, or property tax.
  • There is no personal income tax for non-residents of Delaware.
  • There is no minimum investment required to form a corporation in Delaware.

However, unless you’re forming a high tech startup or some lucrative company that you plan to take public, then consider the type of business you’re in and whether the state where you’ll be conducting business will better serve your financial needs; it often is. Delaware requires you to maintain a registered agent with a physical address in Delaware, which can add needless expenses. Additionally, all Delaware corporations are required to pay annual franchise taxes; these taxes are based on the company’s share value and range from $75 to $180k — plus a $50 filing fee. Delaware also has mandatory annual reporting requirements, which you’ll need to file in addition to those in your home state or states where you are doing business. You’ll also want to keep in mind that if you incorporate in Delaware but will be conducting your business in another state (or states), you’ll need to also file a certificate with the state/s you’re doing business in to qualify as a foreign corporation.

If you decide to incorporate in Delaware, there are some things to point about closely held corporations (called “close” corporations in DE):

  • a closely held corporation in Delaware must have fewer than 30 shareholders and may not publicly offer its stock on a public stock exchange.
  • Subchapter XIV of the Delaware General Corporation Law allows closely held corporations to choose to be governed how they want and all corporations that choose not to will be governed by the general principles of corporate law in Delaware. Thus, states that choose not to carve out greater protection for minority shareholders will not be able to rely on common law to bail them out like in other states. Similarly, Delaware does not have a statute authorizing judicial dissolution of a closelyheld corporation prompted by a shareholder.
  • Delaware is unique with how it handles claims of a freeze-out in a way that provides greater protection for minority shareholders.
  • An impartial provisional director may be appointed by the Chancery Court to settle disputes.

Again, these are generalities and are not intended to provide specific legal advice or delve into the differences between the corporate laws of different states. I would, however, again emphasize that very often the state in which the business is located is often the best state in which to incorporate.

You also have to about whether you’re going to file on your own or through a lawyer. Realistically, the process of incorporating is not overly complicated and can be done on your own. However, there are some things you may want to consider before you make that decision.

The problem a lot of people will run into is that they will rush to incorporate, and use boiler-plate forms or documents they find online as their incorporation papers. Then, years after as the business starts soaring you run into problems with the business entity you chose during filing. This will cause you to spend more money in the long run for an attorney to properly situate your business structure.

The best way to avoid situations like this is to hire a lawyer from the start. Although it may appear as an unnecessary cost, it can have a profound impact. I have founded two separate tech startups, and my lawyer has been essential to my success. I was able to avoid potential catastrophic complications by simply arming myself with sound legal guidance from the beginning. Getting on top of this from day one creates a strong central team that can move your company in the right direction.

When founding my first company, I realized that there is really no meaningful way to find attorneys, compare their prices and services, and get an understanding of who they are, without spending an insane amount of time and head-shaking. With the path to success being so difficult for a startup, why should finding a lawyer be an added hurdle?

This is the biggest reason startups wait to hire a lawyer, or don’t do so at all. When these same companies run into problems later on, the damage can already be done and an unnecessary setback could have been avoided.


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