I am often asked whether a new business should incorporate or form their LLC in Delaware. There are many misunderstood facts about why Delaware is a better place to form your business. Below, I clarify some of the reasons why, for a large percentage of businesses, forming in your home state of California is best.
We’ll begin with why Delaware is often seen at the best place to incorporate. The laws in Delaware are said to be “pro-management”. That means the laws slightly favor CEOs and other managers over the shareholders. This is beneficial to corporations that anticipate having a large number of shareholders. Also, some believe there is a slight prestige factor in having a Delaware corporation.
The Delaware corporate tax rate is approximately 8.7%. Incorporating costs can be as little as a few hundred dollars for those without representation; if a competent attorney is employed, one can expect to pay around $1500 to $2500 or more. These numbers will be slightly less for a Delaware LLC. With either type of company, a registered agent in Delaware will be needed. Franchise taxes are assessed based upon the authorized shares and their par value.
California’s law are said to more “neutral” than Delaware’s in that they do not favor one side more than the other in a shareholder suit. Companies that do business in California must pay tax to the California Franchise Tax Board. The current corporate tax rate is about 8.85%. A minimum franchise tax fee of $800 must be paid annually. No registered agent is needed if the home office is located in California.
When California is Better than Delaware
Since companies that do business in California must pay California taxes, a company incorporated in Delaware will still subject that company to California taxes. It will also have to pay Delaware franchise taxes.
Corporations with a small number of shareholders and those that do not plan to go public in the near future will also benefit from incorporating in California rather than Delaware. Delaware’s strength is its management friendly laws; however, if the corporation is highly unlikely to be sued by a shareholder, the additional headache of paying Delaware tax and continuing the Delaware formalities (like maintaining a registered agent and additional accounting procedures) will become a burden on the fledgling corporation.
Overall, there are very few benefits, if any, for a business owner in California to form a Delaware LLC when the company will be held by only a few shareholders and operated in California.
When Delaware is Better than California
For startups that are only interested in finding venture capital, building a consumer base, and then cashing out, Delaware may offer more benefits than California. Many venture capital firms favor businesses than are formed in Delaware. As discussed, Delaware laws provide better legal treatment to management, and if your company is publicly traded, their laws can protect it from hostile takeovers.
For corporations seeking venture capital with plans to go public, Delaware is likely a great place to incorporate. For everyone else conducting business in California, such as close corporations, LLCs, business owners not likely to go public, California is likely the better choice to form your company. Consulting with a knowledgeable business attorney is recommended to discuss your specific situation.