Which State Should I Incorporate In?

The question of which state an entrepreneur should incorporate or organize his or her business in is an important, if sometimes overlooked, question. Some startup founders simply choose the state in which they live; others choose Delaware without considering why Delaware is a preferable choice and whether the benefits of Delaware are even applicable to one’s business.There are a number of factors founders should consider when deciding what state to incorporate in. Cost Chief among the considerations is cost. Each state has different filing fees for corporations or LLCs. Corporate filing fees are typically based on the number of authorized shares, with a minimum filing fee that authorizes up to a certain number of shares; for example, the minimum filing fee in Delaware is $89, which authorizes up to 1500 shares, whereas the minimum filing fee in Massachusetts is $275 which authorizes up to 275,000 shares. More authorized shares means a higher filing fee. Companies also generally have to pay annual fees to maintain the business’ incorporation/registration. This fee is usually connected to the filing of an annual report, or may be considered “franchise tax”. These fees also vary from state to state. When a company organizes in a hub state such as Delaware while being located in another state, they face the prospect of doubling these fees. Although there are opposing schools of thought, I recommend to clients, whose founders live and will work in Massachusetts, who incorporate in Delaware to register their Delaware corporation to do business in Massachusetts. This requires not only paying Delaware filing and annual fees, but also Massachusetts filing and annual fees. Incorporating in Delaware while being located in another state also requires companies to retain companies to serve as their registered agent in Delaware (the registered agent is the person or entity that accepts legal documents on behalf of the company, and must be physically located in a company’s home state and the states where it is authorized to do business) Laws Another factor to consider, one that tends to weigh heavily in favor of Delaware, is the state’s corporate and business laws. Does the state where you want to form your company legally permit you to structure your company the way you want? If not, you’ll either have to change how you structure the company, or pick another state to organize it in. Delaware is generally considered to have the most modern and flexible corporate laws of any state. Unlike many states, the Delaware legislature regularly updates the business laws to reflect the evolving needs of businesses. For example, last year Delaware added a provision to its corporations law allowing corporate boards to ratify defective past corporate acts as if they were validly undertaken, so that companies don’t have to worry about past defective acts potentially scuttling business deals and operations. Why Delaware? Delaware is one of the most popular states to incorporate or organize a business in due in large part to its modern and flexible laws. In addition, Delaware has a separate court, the Court of Chancery, dedicated exclusively to hearing corporate law disputes; cases are decided by judges who are experts in corporate law, rather than lay juries, and are resolved in weeks rather than the months or years other state trial courts take. With modern statutes and well-developed case law, Delaware corporate law is considered the “gold standard” that every corporate attorney learns and understands, so that lawyers representing clients from all over the country have a common frame of reference. For these reasons, many venture capital and private equity firms require that the companies they invest in be incorporated in Delaware. So Where Should I Incorporate/Organize? My general rule of thumb is if a company plans on seeking private investment within one to two years, they are best served by incorporating or organizing in Delaware — although not every investor requires it, there are those who do, and the ones who don’t require it won’t mind if you are organized in Delaware. It also makes sense to avoid the hassle and expense of reincorporating in Delaware from another state if an investor insists upon it. If a startup has no intention of seeking private investment, or private investment is more of a distant possibility, then it makes more sense in the short-term to simply incorporate or organize in the state where the founders are located. That way, the company does not end up paying double filing/annual fees to form the company — and for most startups, every penny counts.

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