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Should California Businesses Incorporate in Delaware?

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Should California businesses incorporate in Delaware rather than California.  While for a very few, the answer to this question may be dictated by the requirements of Venture Capitalists investing in your business or by a near term trajectory to be a publicly trade company generally my answer to that question is no!  Jon Brooks, a San Jose California attorney provides a more detailed response, which I offer here.  FYI, this applies to both corporations and LLCs and if you are interesting in incorporating or forming an LLC in California, Delaware or another jurisdiction  LINK TO OUR ENTITY SERVICES    please contact  us at 510-444-5082.

 

 

John’s Article

 

 

Question: My start-up business will be based in California. Are there any benefits to forming a Delaware vs. a California corporation?Answer A: If you intend to do business in California (e.g. maintain an office or employees here), and you incorporate in another state, such as Delaware or Nevada, that new corporation will still need to qualify to do business in California. This in turn will make the new corporation subject to California’s minimum annual franchise tax (see the topic “What is the California “minimum annual franchise tax”?” elsewhere in these FAQs). Hence, despite the claims of numerous online “incorporate in Nevada; pay no California tax” storefronts, the latter are simply snake oil salespeople when one considers that their primary audience are California start-up businesses who will likely never have any substantive presence in Nevada. Experienced business attorneys like us help our clients avoid falling for such false claims.

 

But what about Delaware? Every entrepreneur in Silicon Valley hears from one or another fellow business founder, a friend, or other contact that he or she should “incorporate in Delaware.” In fact, it used to be true that Delaware was unique in terms of its case law favoring management’s decision-making in the context of shareholder suits. In other words, Delaware’s courts traditionally, gave deference to the business judgment of officers of corporations when shareholders sued them for various claims. Furthermore, Delaware allowed for expansive indemnification of corporate officers and directors for liabilities that might arise in connection with their duties. However, the entrepreneur might validly ask him- or herself, when might it ever arise that he or she might desire as a shareholder, to sue herself in the capacity of executive officer of the corporation, given that in most San Jose start-up corporations, the entrepreneur will most likely fill all of these roles.

 

In reality, the corporations law of Delaware and California are virtually the same today. Delaware used to be more advantageous in this regard, but California adopted substantially similar indemnification provisions more than two decades ago. The only advantage that Delaware may continue to have, is that Delaware courts have litigated more director & officer liability issues than the California courts, and therefore the case law under Delaware law may be slightly more developed than that of California.

Among the only reasons today for a California entrepreneur to opt to incorporate in Delaware, is a primarily cosmetic one. If the entrepreneur plans to solicit venture capital money, some Silicon Valley VCs still tend to like Delaware incorporations. The VC’s favor Delaware because there is a perception that the director and officer liability is more protective than California’s, that, and let’s face it, simple habit. As noted above, this is probably more perception than legal reality. Many California venture capitalists continue to believe that Delaware corporations are more favorable than California corporations. Since VCs will frequently require upon their financing of a start-up that they name directors and officers for the corporation, it is understandable why perceptions regarding any legal nuance that might lower their risk would die hard.

 

There are, however, significant differences in the ways in which California and Delaware tax the corporation. Delaware imposes a tax based upon the authorized number of shares of stock a Delaware corporation authorizes in its Certificate of Corporation. California does not impose such a tax, but does instead impose a “minimum annual franchise tax” on the corporation even if it does no business in a given year. The impacts of these different taxes will have different impacts on different corporations with differing long term goals for their capital structure.

 

The choice of jurisdiction of incorporation for the new start up business depends on number of practical, legal, and tax issues and should be arrived at only after a thorough consideration of these with our business attorneys and with your accountant.

 

 

 

Disclaimer: The material  in this blog does not constitute legal advice, does necessarily reflect the opinions of the Law Offices of Peter M. Stanwyck or the author of the material if not Peter Stanwyck and is not guaranteed to be correct, complete, or up-to-date. Consult with a qualified attorney to address the specifics of your circumstances.

 

Posted 04 / 27 / 2012

 

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