Should You Form Your Startup in Delaware?

New startups always face the decision of where to incorporate. Often they have heard that Delaware is the ‘best’ place to incorporate for tax or corporate governance reasons. Business owners are not aware of the added duties and responsibilities of incorporating outside of your state of residence. The default should always be incorporating in the state of operations or residence.

Some reasons that businesses choose to incorporate in Delaware include the established case law, securities considerations, and broader corporate governance.

Sophisticated investors will often expect or even demand that Delaware be the state of incorporation. The protections offered to investors and corporate governance leads many venture capital firms to only invest in Delaware corporations. Delaware courts will defer business judgements to the corporate board and officers. Delaware protections for corporate governance makes every business decision that much easy for investors.

While Delaware offers distinct benefits, there are also significant drawbacks to incorporating there. It should be noted that it makes the most financial sense to file your business in your home state in nearly all circumstances.

For smaller businesses, there are usually no real tax savings. Although Delaware does not tax companies not doing business in the state, your home state likely will tax your company’s income. You will need to register your business and pay a filing fee in your home state, and you may also have to file annual reports there. This means twice the work and expense than if you merely registered your business in your home state. 

Your home state may also charge an out-of-state business tax, which, on top of Delaware’s relatively high franchise tax, may not be worth any minor tax savings you do receive. For example, under California law, any company doing business in California, whether registered in the state of California or not, must pay an $800 annual franchise tax.

Major corporations can take advantage of Delaware’s tax laws through a complex process of creating shell companies designed to offset taxes, but the complications and costs of these loopholes are likely out of reach for the average small business owner.

To register in Delaware, you will also have to hire a registered agent within the state of Delaware—an additional cost for your business. If your company becomes involved in a legal dispute, you will have to hire an attorney licensed in the state and potentially travel to appear in court there as well. For more detailed information on the complexities of incorporating in Delaware, you can read the state’s official “Facts and Myths” page.