Why Do So Many Startups Form Their Corporations in Delaware?

Among the many decisions, stresses, and considerations that startup founders face, choosing where to incorporate is not often at the forefront of founders’ minds. While some businesses incorporate in Delaware at the company’s inception, many founders naturally ask why this additional and seemingly unnecessary step is required – or why the company should even incorporate in Delaware to begin with.

However, it should be pointed out that this early decision can have lasting impacts, particularly when startups begin seeking outside capital. As enumerated below, there are many reasons the overwhelming majority of successful startups are incorporated in Delaware.

1. Investors Prefer Delaware Corporations
For many reasons, venture capital firms, angel investors, and startup accelerators prefer— or even require — that startups be incorporated in Delaware before they will make an investment. Investors prefer Delaware for a multitude of reasons (as discussed below), and not being a Delaware corporation can be a potential roadblock startups face when attempting to close a financing.

2. Most Public Companies are Incorporated in Delaware
Nearly 1.4 million legal entities are incorporated in Delaware (including over two-thirds of Fortune 500 companies), and approximately 80 percent of U.S.-based initial public offerings choose the state as their corporate home. As a result, there is broad familiarity with Delaware law among many companies, investors, and attorneys (as discussed below).

A startup that incorporates in another state immediately differentiates itself from other companies just by incorporating in a state other than Delaware – which is not a particularly helpful way for a startup to stand out when seeking capital.

3. Corporations Have More Privacy in Delaware
Every state has its own laws concerning the ability of shareholders to request the books and records of a corporation. Some states make a records request much easier than others, but Delaware does not.

For Delaware corporations, any disputed request by a shareholder for the corporation’s books or records must be made inside the state, which would require the shareholder to obtain local counsel and pursue the matter in Delaware courts. This is likely not convenient and can discourage many shareholders from pursuing actions to obtain corporate records.

Additionally, Delaware is not among the many states which require corporations to publicly identify directors and officers in state filings that are publicly available on state websites.

4. Delaware is Focused on Business
The Delaware legislature pays close attention to developments in business law, which means there are frequent amendments to keep the state’s regulations and statutes up to date. Delaware has a special incentive to maintain this reputation, as it receives several hundred million dollars per year (approximately 15-20 percent of the state’s budget) from corporate franchise taxes. In contrast, other state legislatures lack either the expertise or the incentive (or both) to update such laws with the same frequency as Delaware.

5. Delaware Has Courts that Only Hear Corporate Cases
Delaware has courts that only hear corporate cases. Accordingly, litigants in Delaware can expect to have their cases heard by judges who are focused on corporate law.

In contrast, judges in other states will address matters spanning multiple areas of the law from criminal to environmental to real estate. Such variety makes litigants less confident that a judge will render a correct opinion in their case.

6. Attorneys are Familiar with Delaware Case Law, and It Could Save You Money
The volume of companies incorporated in Delaware coupled with courts focused on corporate cases means that there is a plethora of case law and precedent otherwise unavailable in many other states. In fact, out-of-state attorneys and courts will often cite cases from Delaware as precedent in their own jurisdiction.

Consequently, companies can take advantage of established business laws and know with greater certainty how to avoid litigation and other potential disputes. With the proliferation of Delaware as the preferred state to incorporate, the vast majority of attorneys and investors have become familiar with Delaware’s laws and forms.

As more and more business is being conducted across state lines, this familiarity with Delaware corporate law is especially important. While parties may not be familiar with the particular nuances of each other’s state laws (e.g., Louisiana versus North Dakota), almost everyone is comfortable and knows what to expect regarding companies incorporated in Delaware. In essence, investors and attorneys “speak” Delaware law, regardless of where they are located.

Further, knowing the laws and regulations of Delaware allows startup companies and investors to keep legal costs lower and improve efficiency, which ultimately allows for financings to close quicker than if the parties had the additional responsibility of understanding another state’s laws (along with any potential liability or roadblocks associated with that state).

7. Delaware is Efficient, for a Price
While other states may take days to process a company’s filings, Delaware typically takes far less time — and can do so in as little as one or two hours for an additional fee. These quick turnaround times and a responsive Secretary of State’s office in Delaware can be essential in terms of moving a financing or merger along expediently.

However, there are additional costs a company must cover when incorporating in and maintaining the corporation in Delaware. For example, in addition to initial state filing fees, a Delaware corporation also needs to pay an annual fee, registered agent fees, and franchise taxes.

These are in addition to the fees a startup would have to pay to be registered to do business in its home state as well as any other state in which it is doing business. That being said, while incorporating in Delaware does have additional costs, it also comes with convenience and efficiency.

Conclusion

Not all is lost if a company chooses to incorporate in another state, as it is still possible to convert to Delaware later on, if necessary. However, converting to Delaware later on can be costly in terms of finances (e.g., additional filing and attorneys’ fees) and time. For this reason, it is often beneficial to incorporate in Delaware at the outset to avoid explaining to investors why this was not originally done, as well as to avoid the cost and time of converting to Delaware during what is already a stressful situation in seeking additional capital to grow the business or simply stay afloat.

While incorporating in other states does not preclude a business from obtaining outside capital, choosing Delaware can help make the process smoother. As noted above, Delaware can be more expensive than simply incorporating in the startup’s home state, but it does benefit companies legally and administratively in many circumstances.

Overall, though, the familiarity of investors and attorneys across the country with Delaware law is a major contributing factor for why so many startups ultimately decide to incorporate in Delaware. The ability for both the investor and company’s teams to be working from the same forms and legal backdrop can be invaluable: communication, as it often is, is key.