Why do so many companies choose to incorporate in Delaware?
Over half of the publicly traded fortune 500 companies have chosen to incorporate in Delaware. These companies certainly had good reasons to choose Delaware – they would not be fortune 500 companies if they consistently made bad decisions after all – but are their reasons right for you? Not necessarily – be careful to consult with your legal advisors, CPA or CFO before making the plunge.
Many of the advantages of incorporating in Delaware apply primarily to large corporations, but not so much to small companies. For example, the Delaware Court of Chancery, unlike most states in the USA, does not employ the jury system. That means that if your company faces litigation, and especially a class action suit, it is less exposed to exorbitant punitive damages. Furthermore, the very fact that Delaware is a hub of company incorporation means that US corporate attorneys are likely to be most familiar with Delaware law, rather than the laws of other states, meaning that you will, on the average, be better represented in Delaware than elsewhere. Of course, if you are a smaller company with little exposure to litigation, this is less of an issue.
Taxation wise, companies incorporated in Delaware that do not conduct business there are not required to pay state corporate income tax (though there is a franchise tax), or, of course, payroll tax or sales tax, simplifying your taxation structure. Likewise, shareholders who hold Delaware company stocks who resides outside Delaware aren’t subject to Delaware taxes.
Given these taxation issues, the lesser exposure to punitive claims, and the “brand name” of Delaware, investors and investor banks also favor Delaware incorporated companies and may offer you better terms. Once again, the extent to which this is an advantage is dependent on whether you depend on investment capital for operations.
Finally, when your company is incorporated in Delaware you enjoy greater flexibility, and privacy when structuring your company. Shareholders, directors and officers need not be residents of Delaware, a single individual can be the sole shareholder, officer and director of the corporation, unlike other states where there is a demand for minimum 3 directors, and the names of the officer and director need not be divulged in the formation documents.
What are the drawbacks to incorporating your company in Delaware?
Given all of these advantages, what possible reason might you have not to incorporate in Delaware? Well, first of all you need to see if these advantages actually benefit your company. If you are a small company operating on self-capital, meet the structuring requirements of other states, have no concerns regarding litigation or the privacy of your officer or director and are based and conduct business outside Delaware then there is no real advantage to incorporating in Delaware.
In fact, if you choose to incorporate in Delaware while being based in another state, you may need to pay the annual franchise tax in both states and also need to follow the reporting requirements for both states, resulting in greater costs as well as considerably more hassle – clearly suboptimal financial planning.
To summarize, you should carefully consider whether your company stands to benefit from Delaware incorporation, taking into account the legal environment of your home base and major markets and how they overlap. Outsourced financial planning can help your CFO craft the business plan that is best for your company.