So many owners of small or mid-sized businesses ask us about the benefits of incorporating their entities (corporation or LLC) in Delaware. There is clearly an assumption in the business community that there has to be some benefit to Delaware registration. Why else would most of the Fortune 500 companies do the same? Our usual response is that for most small and medium-sized businesses headquartered outside of Delaware, it makes little economic or legal sense to incorporate in Delaware, notwithstanding the mystique surrounding a Delaware incorporation.
Why are some of the largest companies in the U.S. incorporated in Delaware? Delaware has a long history of welcoming corporations. It was one of the first states to pass legislation governing corporations, including modern corporate registration statutes. This legislation has largely been tracked by other states. Delaware was one of the first states to pass management protection laws favorable to corporate decision makers. Delaware has a separate Court of Chancery with experienced, business-oriented judges that only hear cases involving business disputes and corporate governance. As a result, Delaware has a very rich history of case law decisions on corporate matters, and most other state courts have followed Delaware’s lead in this area of law. In addition, most venture capitalists and investors prefer that their targets be incorporated in Delaware, regardless of where they are actually headquartered, so that the Delaware courts have jurisdiction over future disputes.
In our view, for most small and mid-size companies, incorporating in Delaware is an unnecessary expense. For most companies, there is no tax benefit to doing so because corporate income tax is paid in the state where the income is generated, not where the company is incorporated. In addition, by incorporating the entity in Delaware, you subject the entity to being sued in Delaware, which may not be a convenient forum for you. Furthermore, since an entity is generally required to register in any state where it has offices or conducts substantial business (and appoint a registered agent in each such state), incorporating in Delaware means paying initial registration fees, on-going yearly fees, and registered agent fees in multiple states, which can be a substantial expense.
A number of years ago, our firm represented a local corporation that had incorporated in Delaware for no particular reason. Several years later, the owner discovered the registration in Delaware had lapsed, and the corporation owed tens of thousands of dollars in unpaid annual franchise taxes to the state. We were able to somewhat lower the total bill through an appeal with the Delaware Division of Corporations, but ultimately the corporation had to pay a significant portion of the back taxes in order to maintain the entity and its valuable contracts. Following payment, we quickly domesticated the corporation in Virginia where it was actually operating.
There are many online services that seek to incorporate your entity in Delaware for a fee. Some of those fees can go be as high as $3,000 or more. Consult with your legal counsel before taking the plunge, or you may find that you have made a very costly mistake. Here are a few of the false claims made by some of these online companies:
(1) you can reduce your taxes because of the low corporate tax rate in Delaware,
(2) there is more privacy for your personal information in Delaware, and
(3) the prestige of a Delaware entity is worth the cost.
Many states, including Virginia, are also corporate friendly states like Delaware. If privacy is a paramount concern of yours, speak with an attorney about the various ways to keep ownership information private wherever you incorporate. If you are fortunate enough to own a business that others wish to acquire or invest in, your entity can quickly be domesticated in Delaware if required by the buyer/investor.